Book Review: The Snowball Effect – Using Dividend & Interest Reinvestment to Help You Retire on Time

The introduction to The Snowball Effect: Using Dividend & Interest Reinvestment to Help You Retire on Time written by Timothy McIntosh starts with a well-known quote from Warren Buffett about how to approach investing and making money in the stock market.

“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”

This quote then serves as a thread throughout the book as the different parts about dividend investing are accounted for. The main theme in The Snowball Effect is how dividends should be considered by any long-term investor as a crucial part of the total returns. And, for sure, wouldn’t it be great if you knew that you’d have recurring dividends coming into to your account, certainly if the stock market were to close down for some time (hopefully it won’t).

The Snowball Effect starts off with a discussion about the different secular bear markets that’s taken place from 1906 up until 2011. And I’m pretty sure that many of us are familiar with the mantra “stocks always go up.” A statement that, according to the author himself, is “a falsehood.” To back his view up the author lays out some interesting statistics that also serves as a great summary of financial stock market history. The different secular bear markets up for an review by the author are the ones occurring in 1906-1924, 1929-1954, 1966-1982, and 2000-2011.

Except for the historical lessons in this book, I also enjoyed all the data provided regularly throughout about dividend yields and stock market returns, just to give a few examples. Also, there’s an interesting table in the midst of the book summing up the best and worst single days in the DOW. A table that in hindsight serves as a fascinating read and reminder of Mr. Markets presence throughout the years.

Another theme is the collection and reinvestment of dividends back into the stock market to increase the future dividend power of your stock portfolio. A great way enabling the investor to (hopefully) collect stable and growing cash returns in the future, especially if the stock market enters into another secular bear market.

The author provides the reader with some checks to be used when picking the best dividends stocks, what to look for, as well as some guidance on market timing (even though timing is a tricky part of it all as we know when it comes to investing).

The dividend yield, that is dividend in relation to price, is a metric that is often shown on different sites and also in most investment publications. Inverting the dividend yield we get the price to dividend ratio, about which the author writes:

If you apply a price-to-dividend ratio analysis to stocks you are thinking of purchasing or already own, you can purchase, or reinvest, cash at optimal points in time. If Pepsi’s share price falls and the yield nears 4 percent, the investor could then time her purchases in the most efficient manner and gain the most shares of Pepsi stock possible. Following this type of market timing will allow an investor to collect more share of a company’s stock at the times when it is most undervalued.

The reader also gets a chapter devoted to the covered-call strategy in dividend investing, and a chapter with a discussion of what makes the best investment area when it comes to dividends (micro-cap or larger-cap dividend firms).

To sum up, this is a book well worth reading. With the important overall topic about dividends (as one of the factors in the calculation of the total return) the book’s building blocks (see table of content below) make this a great read.

Summary of Content

Introduction

Chapter 1: The Treacherous Secular Bears

Chapter 2: The Power of Dividends

Chapter 3: The Snowball Effect: The Promise of Reinvesting Income

Chapter 4: The Small-Cap Paradox

Chapter 5: The Power of Bond Interest

Chapter 6: The Covered-Call Strategy

Chapter 7: The Future and the Top 100

Suggestion for Additional Reading

The Top 100 List

Disclosure: I received the book in this post without having to pay a cent. Regardless, as in any case when I haven’t received something, I only make recommendations I personally believe will be of benefit to my fellow readers. I cannot tell for sure whether the fact that I received the book for free made me write this post, i.e., reciprocation tendency. I sincerely hope that I would have written the same words in a situation where I had bought the book myself. Except for receiving the book for free (and the stamps on the envelope) I have not, and will not, be compensated in any way for any further writings etc. If you want me to review a book, please let me know.

Disbursing Cash to Shareholders

“When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases.” ― Warren Buffett, Shareholder Letter 1984

Capital allocation

Capital allocation is an important area when it comes to running a business, and it’s important to understand both sides of it, re-investing capital in the business versus distributing cash back to shareholders. The managers in charge of making these kinds of decisions have to have the knowledge to know the pros and cons, and thus be able to make the best capital allocation decisions possible to create the most value there is to create for shareholders of the business.

Also, as an investor you need to be able to understand the capital allocation decisions made by mangers and how it all affects the underlying value of the business, and if the capital allocation decisions made look reasonable and thus value creating or done mostly in the interests of the managers themselves, for example retaining earnings to build an empire that leads to bigger paychecks etc.

Disbursing Cash to Shareholders: Frequently Asked Questions about Buybacks and Dividends

A great way to learn more in this area is to read this recently published report discussing a few of the issues when it comes to disbursing cash to shareholders. This new report is written from Michael J. Maubosin and Dan Callahan, both currently at Credit Suisse. The report can be found here.

The following graph is found on the front page of the report, showing the historical growth in dividends, buybacks and the S&P 500 during 1982-2013.

BD1

The front page also contains the following summary points about the topic of buybacks and dividends addressed in the report. Have a look at them and then take some time to read the report itself.

  • Corporate cash balances are building because Corporate America’s return on investment is high and its reinvestment rate is modest. The issue of disbursing cash to shareholders is a crucial and timely issue in determining shareholder value.
  • Share buybacks and dividends are two methods to return cash to shareholders. Executives view the two very differently and are often unsure of the best way to proceed. Superficial media coverage and wide-ranging input from investors drives this confusion.
  • This report answers frequently asked questions. This format allows us to cover the pertinent issues as well as address a number of canards that persist with regard to these topics. 
  • A company should retain its earnings if it can earn a rate of return that is above the cost of capital. But if shareholders can earn a higher rate of return on capital than the company can, the company should disburse the cash.

The report is well worth reading, so check it out here.