Wednesday, January 11, 2012

Foolish Return Analysis

A while back, the Jaded Consumer ran an article on The Motley Fool's seemingly opposing investing advice and the dizzying array of stock picks offered in its numerous paid newsletters. In it, The Motley Fool's method of comparing users' stock picks to the S&P 500 index performance was criticized in passing as mishandling dividends. The point of this post is to illustrate that comparisons on The Motley Fool between users' stock picks and the S&P 500 are absolutely rubbish when dividends are involved.

The Motley Fool's method of handling dividends is not to add their return to the capital return. This method would err by ignoring the tax inefficiency of dividends, which are taxed in the year paid while capital gains go untaxed until realized, and err further by utterly ignoring the time value of money – that is, the difference in value of having a dollar of liquid return today versus having it paid to you in three years. Instead, what The Motley Fool claims it does is much worse: it subtracts dividends from users' basis. Confusing things further, The Motley Fool avoids negative basis by applying an undisclosed method to avoid ever hitting zero. According to the site, "The adjustment will be a fractional deduction, and not a flat dollar reduction. This prevents the cost-basis from ever reaching zero." The method also prevents anything like accuracy, or even duplication by third parties.

For purposes of example, and to show the absurdity of The Motley Fool's method by looking at a dividend stock, The Jaded Consumer will look at American Capital Agency Corp. (AGNC), which has been written about here on numerous occasions (mostly because it is managed by ACAS, about which much is also written here).

Let's have a look at a user who picked AGNC as a "buy" at The Motley Fool. The "buy" pick for this user was made on Thursday, September 4, 2008 – a day in which AGNC traded between $18.25 and $18.69. To give The Motley Fool the best possible case of accuracy, we will assume that the user made the pick at the exact time of day needed to nail the day low of $18.25. Given today's closing price of $$28.11, the user would (if the user had made a real buy, and held) enjoy an unrealized (and untaxed!) gain of $9.86 – for a not-too-shabby 54%. (By comparison, the SPDR S&P 500 ETF Trust – designed to mimic the performance of the S&P 500 – which traded at a low of $123.96 on 9/4/08, closed at $129.15 today, thus yielding a rather lower return even after considering several years of its single-digit dividend yield.) Holding for all this time would have entitled a user to some dividends, the history of which is readily available from the NASDAQ web site. Holding from 9/4/08 through the 1/27/2012 payment date would have entitled an investor to a $1.00 dividend, a $1.20 dividend, a dividend of $0.85, a dividend of $1.50, and for the last ten quarters a dividend of $1.40 apiece. This totals $18.55, which (ignoring time-value-of-money considerations) would amount to 101.6% of a the hypothetical $18.25 purchase price. Adding the capital gains and dividend returns would yield at best (ignoring time value of money considerations) a gain of $28.41, or 155.6%.

Yet, the CAPS participant we're looking at, having given the thumbs-up and a 3-year investment horizon to ACAS on 9/4/08, is credited with having already bagged a whopping return of 212.93%, even though the results at The Motley Fool cannot yet reflect the 1/27/2012 dividend (which hasn't yet been paid and won't be owed a shareholder until the ex-dividend date passes):

The real mystery is the purported Start Price. AGNC never traded for $9, ever. And this user's happy return is not really greater than a total return of 300% (yet) as suggested by the 212+% gain claimed at The Motley Fool.

The Motley Fool CAPS system that produces these bogus returns is not the only place one can get confusing results. The Motley Fool has a portfolio-tracker that will help calculate an annualized return that can be compared to that of the S&P, but that tool ignores dividends altogether. An investment in AGNC over the last year doesn't look like it's enjoyed a double-digit return, it looks flat.

For a site dedicated to helping users understand investment returns, The Motley Fool has a few things to straighten out – particularly with respect to making sense of the return obtained from dividend investments.

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