WALL STREET (JOURNAL) GIBBERISH, 2013 FIRST QUARTER NEWSLETTER

I use this occasional feature to expose spoken or written "wisdom" that is technically correct, but is also misleading and potentially harmful to investors’ financial well-being. This issue’s likely is not harmful, but it shows how some try to “game the system,” often to the detriment of ordinary investors.

Jason Zweig writes a weekly “The Intelligent Investor” column in The Wall Street Journal, which often has valuable insights. That was not so in the March 23 one that discussed, somewhat favorably, the notion that long-term holders of a stock should receive loyalty rewards from the company. (Federal tax laws impose a lower rate on shares sold after being held for more than a year, so there is already a potential benefit for not selling quickly.)

Several types of businesses such as drugstores, airlines, and credit cards reward those who continue to patronize them. Airline miles are an obvious example, and two local Washington DC area grocery chains reward those who buy enough in a given period with increasing discounts on gasoline purchases. So why shouldn’t a company provide benefits to its most loyal “owners”? One idea is paying a modestly higher dividend to the longer term holders of the stock.

According to the article, in the 1980s one company gave extra voting rights to those who had owned the stock for at least four years. It was terminated once investors realized that the main beneficiaries were the insiders—mainly top management—who gained the most from the provision. That would also be the case for an increased loyalty dividend.

A more fundamental question is how a company would benefit from having more longer term owners of its stock. It makes sense for an airline to try to get you to fly with them rather than one of its competitors, and frequent flyer miles can serve that purpose. However, someone is going to own every share of a company’s stock, so the company does not need to attract more stock holding “customers.” It is possible that the prospect of a higher dividend from holding the stock long enough could increase demand for the stock and result in a higher price for the stock. That could benefit the larger holders and possibly the company if it wanted to use its stock to attract key personnel or acquire a business using stock for part or all of the purchase. On the other hand, the company would have to pay out more in dividends, which can reduce funds available for corporate purposes. Also, reducing the amount of trading might result in less liquidity and consequent less favorable prices when buying or selling the stock.

One reason to encourage longer term ownership according to the article is that there is a lot of high speed trading, which can lead to large single-day moves, drops likely being bothersome to the major holders, in the price of a stock. However, that trading is done mainly by institutions such as mutual funds, most of which want to avoid showing “dogs” when they report their portfolios, and those using quantitative algorithms and computers to scalp small profits many times during a trading session. A loyalty reward would have no effect on such activities.

The article says that the potential for sudden drops in the stock price can make managers “gun-shy.” It cites a 2003 survey of over 400 senior executives that found 59% would not “invest in a project that would generate significantly higher long-term profits if it reduced earnings in the short run.” I suspect attitudes have not changed much since then.

So the real problem is not how often the stock is traded, but is the tendency of the top management of some companies to be preoccupied with its stock price, even to the detriment of the firm. The discussion about rewarding long term owners of the stock is at best a distraction from the important concern, which makes it Wall Street Gibberish.

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