Lowell Miller’s Single Best Investment

If I had to select only two investment books, my first choice would be David Dreman’s The Contrarian Investment Strategies: The Next Generation. My other choice would be Lowell Miller’s Single Best Investment.

Lowell Miller summarizes his rules in Chapter 10 of The Single Best Investment. Just before he goes over the rules, he makes a critically important point about his dividend strategy.

From page 166: “Remember, we are not trying to beat the market here, nor are we even seeking what others might call the best stocks. We’re trying to create a compounding machine that will be robust and durable for at least an entire investing life, one that will provide equity-like returns with some measure of reliability and predictability over time, one whose income will rise. And because its income rises, the investment will also rise in market value.

Later, he repeats the basic formula:

“High quality + High yield + Growth of yield = High total returns.”

Those familiar with the Dividend Discount Model (and the Gordon formula) will recognize that the sum of the dividend yield and the growth rate of dividends provides a discount rate assuming that the dividend growth rate is constant. Assuming that all dividends can be reinvested in a similar manner, this discount rate is also the long-term total return of a stock. For shorter periods (of 10 or 20 years), you must make adjustments for valuation changes in the Price to Dividend ratio (or dividend yield since the Price to Dividend ratio equals one divided by the dividend yield). In terms of an income stream, the basic formula does not need this adjustment. Once again, to apply the formula directly, all dividends must be reinvested and they must be reinvested at the same rates.

Lowell Miller recommends starting with a reasonably high dividend yield because (projected) high dividend growth rates can disappear and because it can take a long time for dividends to grow into a substantial income stream if the initial yield is too low.

My own experience has been that trying to match the market’s returns is likely to succeed beyond expectations and trying to beat the market is likely to lead to disaster.

Here is an outline with some of his rules:

1) The company must be financially strong. Lowell Miller gives us a useful short-cut: make sure that its bonds are investment grade (S&P ratings of BBB+ or better).
2) Require a relatively high current yield, typically twice that of the overall market and never less than 150% of the yield of the S&P500.
3) Be sure that earnings growth will support dividend growth. An earnings growth of 7% to 10% is sustainable for a large company.
4) Look for good valuations: a price to sales ratio of 1.5 or better with a price to earnings ratio and a price to book ratio below the market. Cash growth is a big plus.
5) Use charts to buy, but not to sell. Look for rising relative strength after at least six months of underperfomance.
6) Sell whenever the dividend is in doubt, when it has not been increased in the last year (i.e., twelve months) or when the story has changed.
7) Diversify extensively. Invest using equal dollar amounts for each stock.

There are other factors such as the quality of management. Lowell Miller gives you some hints that you can use as opposed to parroting a cliche.

Here is the kind of insight that Lowell Miller is able to provide.

Lowell Miller’s company “conducted the only long-term study that exists of utilities as an class.”

From page 174: "For the period of our study, 1945-1990, Dow Jones Utilities Index average annualized return was 11.75%, or 7.50%, after adjusting for inflation, which averaged 4.7% during those years…During the same time frame, long-term bonds returned 5.60%, or a paltry 0.85% after adjusting for inflation…The S&P500 returned slightly more than the utilities at 12.25%, but the S&P500 was almost twice as volatile as the utilities or, as the consultants like to say, twice as risky. In other words, on a risk-adjusted basis, the utilities were almost twice as attractive as the overall market….”

For the utility sector: “…What we have found is that the highest-yielding utilities typically offer the worst total returns, whereas the middle and lower yielders that also have some growth kicker are by far the best bets.”

Reaching for yield by itself is always risky. But reaching for yield while insisting on quality is a much different story.

Have fun.

John Walter Russell
I wrote this on May 13, 2005.