Don't Let Your Investment be Diluted

This article originally appeared on The DIV-Net on 2009-09-02

High return on equity (ROE) and a reasonably high dividend yield are good things to have in stock investment. But investors focusing on just these two metrics (or any other few metrics) might be surprised to discover they are losing money.

This is the case of CenterPoint Energy (CNP), a utility company with interests in electricity, natural gas distribution and pipelines. Since 1999, CNP has returned $8.78 per share to shareholders via dividends. The average annual dividend yield since then has been between 3.11% and 6.83%.

The return on equity has been solidly between 10.3 and 34%, with the average just over 21%, which is pretty good considering that an average business gets less than 12% and utilities are lucky to strike above 8% ROE.

But long-term investors received little for holding the stock for the last 10 years. In fact, they lost money after inflation, through equity dilution.

An investor who was lucky to buy a share of CNP in 1999 at the lowest recorded price for that year ($22.75) and held on until the very peak price in 2008 ($17.35), would have gotten a total cumulative return of around 8%, including dividends, which translates to 0.89% annualized. That's less than inflation.

Even if we consider that in 1999 the market was very inflated and in 2008 it was really low overall, this exercise assumed an investor was lucky enough to buy at the trough and sell at the peak. Most investors won't get these prices.

But let's exclude 1999 as it was a local market peak and also 2008 since it was an abnormally depressed year. Let's continue to assume our investor was lucky and bought at the lowest point in 2000, collected dividends until the top of 2007 and sold at that high price.

Even in this scenario, the cumulative return amounts to only 24% or 3% annualized, barely keeping up with inflation.

The table below summarizes why.




Price: High$32.50$49.00$50.45$27.10$10.49$12.32$15.14$16.87$20.20$17.35


Price: Low$22.75$19.75$23.27$4.24$4.35$9.66$10.55$11.62$14.70$8.48


Dividend per Share1.501.501.501.070.400.400.400.600.680.73


ROE (%)3414.314.810.326.414.418.730.323.723.2


Yield on avg price5.43%4.36%4.07%6.83%5.39%3.64%3.11%4.21%3.90%5.65%


Shares outstanding286284292299306364336324341343


Long term debt$5,666$5,701$6,448$9,149$10,783$7,193$8,568$7,802$8,364$10,181



$ Return% ReturnAnnualized


Return from 1999 low to 2008 high$1.888.26%0.89%


Return from 2000 low to 2007 high$4.8224.41%3.17%

CNP has been diluting shareholders returns via stock options and outright sale of stock and at the same time maintaining or increasing its debt. These management actions proved to be unfriendly to shareholders and thus investors should continue to shun this stock.

Dilution of shares and high debt are characteristics of capital-intensive companies with high fixed charges. Careful investors should be on the look out for such companies and invest only when it makes sense to do so.

Value investing is not only about finding bargains. It's about finding wonderful businesses at reasonable prices.

Disclosure: no position in CNP at the time of writing.

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