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Resisting Yield:

I received an email this morning from John who wrote:

I noticed that when you bought shares in RUS (Russel Metals) back in January your yield at purchase would have been over 8%. At the time you stated that the dividend was safe based on adequate cashflow, a commitment by management, minimal debt and prior periods of slower demand in which the company continued to pay the dividend. BMO (Bank of Montreal) hit a yield briefly yesterday of 6.5%. Have you done an analysis on this stock and if so, is the dividend safe?

Yesterday and again early this morning the yield on BMO tipped above 6.50% (at $43.07) for the first time since March 19th, 2008. There are a few lines of thought currently on Canadian banks; specifically CM and BMO.

These include:
· No Canadian bank has cut its dividend in recent memory (decades, if ever)
· Canadian banks are more conservative than their US or international counterparts
· Instead of cutting the dividend a Canadian bank would likely issue a stock dividend instead or continue to raise more capital via preferred or common stock issues
· Many of the significant writedowns have already occurred and are likely to be written up in future quarters leading to higher profits.

While any or all of these might be true, I’m still hesitant to draw a definitive conclusion. First it’s been just over a year since I posted on concerns I had about BMO and since that time the lack of transparency in their CDO and SIV obligations has been disappointing to say the least. While some banks have publicly disclosed the extent of their exposure to poor credit, there are others who continue to suffer the consequences of not showing the market what lurks in the shadows.

What this leads me to conclude is that while there might appear to be incredible upside in the dividend and BMO trades at an attractive P/B of ~1.6x, during 1988-1996 it traded at an average P/B of 1.25x which would place it at an approximate value today of $35/sh. While we’ve seen BMO trade down to $38 so far this year, it certainly isn’t unforeseeable in the event of more unexpected losses for the stock to lose 15-18% of its value and/or cut its dividend when you add to this the abundant issuance of preferreds by the banks.

What an investor should to do is weigh the risk/reward of the investment and make a decision based on their own tolerance. Management to date has not instilled confidence through their actions or public disclosures for me to take that sort of risk.

While it might be easy to compare the past yield of RUS to the current yield of BMO; my analysis of Russell’s dividend was simple, clear and transparent based on the operations of the company, publications made available and long established commitment to shareholders by management.

Taking a position in BMO at these levels might turn out to be an attractive long-term opportunity, but for my investing discipline the company lacks much needed criteria to become a part of any of my portfolios at this time. One of my strongly held beliefs is that management is key and I have yet to see the whacking stick rise over the heads of those who need to be shown the door before I consider BMO or CM as an investment.

Disclosure: I own positions in BNS, RY & TD and indirectly to CM through MFC.

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{ 2 comments… add one }
  • Dividends4Life June 25, 2008, 1:06 pm

    > What an investor should to do is
    > weigh the risk/reward of the
    > investment and make a decision
    > based on their own tolerance.

    Excellent point. What’s right for me may not be right for you. Great read!

    Best Wishes,
    D4L

  • Nurse B, 911 June 25, 2008, 3:32 pm

    Thanks D4L,

    I try to emphasize that point as often as I can. While I respect an investors opinion on a stock, that specific investment might be against my risk tolerance and therefore not appropriate for me. I might have exposure to another stock already and don’t need to duplicate, feel uneasy about the direction the company goes in or simply not understand it.

    Forming your own opinions and weighing them against those of others makes a very real difference in long-term success.

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