8/18/08

Motley Fool Income Investor Review

The Motley Fool Income Investor is run by James Early and Andy Cross. The newsletter is "dedicated to provide the best total returns through winning dividend stocks."

The following review uses some of the same analysis as was used in my review of Motley Fool's Stock Advisor.


Content

Just as with Motley Fool's Stock Advisor, when you log on to Income Investor, you're presented with an easy to navigate layout. There are three main links: to the latest newsletter issue (published once a month), the newsletter's performance (tracked from the September 2003 issue), and the best previously made recommendations to buy now. When on the current issue page, you can find a link to and read all the past issues, going back to September 2003.

The home page also features updates on past stock picks, as well as links to Motley Fool articles and discussion board messages relating to the newsletter's picks. There is also an "Online Exclusives" tab, which features updates on previous picks, dividend tax tables relating how each pick's dividend is treated by the IRS, interviews with CEOs (as of writing, the last interview was posted in October 2007, almost a year ago), and "Special Reports" (tax tips, Income Investor 12 month recap, articles on dividend paying stocks, etc).

Each monthly newsletter issue, which you can view in html on the site or download as a pdf (a paper version also comes in the mail), ranges from around five to ten pages, and always contains an introduction, Early's pick, Cross' pick, and a "question and answer" section (it's called "Dueling Fools" in Stock Advisor). Most issues have something called "Over/Under" and "Profit Playbook." Many issues, but not the majority, contain updates on previous picks and short articles of the same type as you'll find on the Motley Fool website for free (minus advertisements--both 3rd party and for Motley Fool services), a rare bonus stock pick, and/or reviews of Early's or Cross' performance. Some issues have all of these, some have none.

Each month's introduction is written by Early or Cross, and contains either something general about dividend investing, the newsletter, an anecdote, or something similar to what you'll find on the Motley Fool site for free.

Early's and Cross' stock picks are usually one or two pages in length each. These are short blurbs on the reasons for buying the particular stock and what its fair value is. The page also includes a brief summary of company data (location, website, market cap, etc). In the pdf version there is also a two year chart. For purposes of illustration and comparison, take a look at Value Line. Look at "Part 3--Ratings & Reports" in the samples section. Income Investor picks have a lot less in terms of the company's financials, and about twice to three times as much in terms of text.

The text portion usually amounts to under 1,000 words. This could be a good thing or a bad thing. On the one hand, as an investor (especially one paying for a stock recommendation service) you would presumably want to be given as much information as possible before making your decision. On the other hand, if you're already paying for stock recommendations, you probably don't feel like spending too much time reading and sifting through mounds of data. As long as the recommended stocks go up, most subscribers probably take the latter view.

Since each month's picks are Early's and Cross' best ideas for the month, it is not unusual that the same stock gets recommended more than once, although this happens less frequently in Income Investor than it does in Stock Advisor.

The "question and answer" portion of each issue concerns the recommended stocks in the issue, and perhaps the recommended stock's industry, or some general investing theme relating to the recommended stock. The advisor who didn't recommend the stock asks the recommender questions, attempting to flesh out the pros and cons of buying the recommended stock. This usually runs about 500 to 1,000 words per stock. This section is meant to cover things neglected on the stock recommendation page, and perhaps ask some questions subscribers would have. The question/answer format makes for easy reading, which is a plus.

Just as with Stock Advisor, however, the nature of the questions is not very pointed. That is, the questions aren't meant to really point out the flaws of the stock recommendation. Rather, the questioner seems to know what the answers will be ahead of time. There is also a touch of humor with the questions and answers, and the section frequently ends with a joke. "Fun writeups" are standard at the Motley Fool. It doesn't appeal to me, but it does make Motley Fool different from other stock advisors, and I'm sure many investors find it enjoyable.

The "Over/Under" section is usually written by someone other than Early or Cross. The section is meant to offer investment ideas for subscribers looking for higher dividend yields or growth potential. These investments are higher risk, and are not official picks. This section runs around 1,000 words, and is about one or a few stocks. The section appears to have been called "Cash Flow Corner" before 2008.

The "Profit Playbook" is also usually written by someone other than Early or Cross. It is similar to the types of articles you'll find on Motley Fool for free (but again, without the advertising). For example, August 2008's Profit Playbook discusses whether investing in oil is still a good idea.

The company updates section usually consists of a paragraph about each update of a past recommended stock. The update concerns company news, movement in stock price, industry developments, and the like. The number of companies updated ranges from one to ten. Company updates are available on the newsletter home page. Email alerts are also sent out.

Occasionally, issues (this also comes in an email update and is available on the home page) have sells of past recommended stocks. Since September 2003, around 1/3 of the picks have been sold. Sell recommendations don't come suddenly, as the stocks in question are usually mentioned in updates weeks or months before the actual sell recommendation is made.

Besides the newsletter, there is a series of discussion boards. All the recommended stocks have discussion boards. There are also various boards devoted to different topics like investing philosophy, buying strategies, dividends, budgeting, etc. Whatever you can think of, there's probably a discussion board devoted to that topic. Subscribers and Motley Fool employees post here. Think of the Yahoo! Finance boards but with intelligent discussion.


Performance

Pick performance is measured "by adjusting the cost to reflect dividends, subtracting the current price, and then dividing the difference by the original cost basis. Returns are tracked from the price of the recommendation at the time of release to the stock's most current quote."

So, for example, let's say stock ABC trades at $100 a share when it's picked. Suppose after a couple of years the stock trades at $120 and has paid out a total of $8 in dividends. The return would be calculated as follows: $100 - $8 = $92 (this is the adjusted cost basis). $92 - $120 (the current price) = -$28 (the total gain). -28/100 = -0.28, or -28%. Since this is a gain, we multiply it by -1, to get the total return of 28%.

All this is to say that dividend payments are counted in each pick's performance. The Income Investor's total performance is the average of all the picks' gains and losses. This includes stocks recommended last month as well as those recommended in 2003. As of writing, Motley Fool's Income Investor has an average gain of 16.02%. Suppose you bought every pick when it was recommended and sold everything that Early and Cross sold. Let's say you spent $10,000 in total. Your portfolio would be worth $11,602 today. This amounts to an annualized gain of just under 3.06%.

Performance is also measured as against the S&P 500, both for each stock picked and for the average return. For example, a stock picked in June 2004 is compared with the S&P 500 from June 2004.

As of writing, the S&P's average gain is 7.42%. The Income Investor newsletter is outperforming the market by 8.6 percentage points. Better than most mutual funds.

Since the newsletter focuses on dividends, yield on cost would perhaps be a better measure. Yield on cost is a stock's annualized dividend divided by your cost basis. A dividend investment can be a good one even if the total return (which incorporates stock price) is poor, as long as the yield on cost rises. Yield on cost rises when the dividend paying stock increases its payout.

For example, suppose your portfolio consists of one stock, XYZ. Let's say you bought XYZ at $50 a share, and it paid an annual dividend of $2 a share. The yield when you bought XYZ was thus 4%. Suppose XYZ now trades at $30 a share. Ouch! But let's say it pays a dividend of $4 a share now. While you're down quite a bit in your total return (depending on how long you've held the stock), your yield on cost has doubled. Since you originally paid $50 a share, your yield on cost is now 8%. If there's nothing wrong with the company (let's say its share price is down because it's a bear market) and its dividend is stable, from an income investor's point of view the investment is a good one. Your dividend payments have doubled. Since there's nothing wrong with the company, you should eventually have a decent total return.

Unfortunately, Motley Fool's Income Investor does not include this measure. This is probably because its mission is for "best total returns." Given the amount of time it would take, I do not calculate Income Investor's yield on cost. Perhaps Income Investor's yield on cost has improved, and its paltry return of 16% in five years isn't so bad.

Yes, it's beating the market, but the same amount of money in certificates of deposit over the same period would have given you a better gain, without the risk associated with stocks. Moreover, if we factor in the newsletter's fees, depending on how much you would have invested, you might've been better off buying the S&P 500 instead. For example, suppose you invested $10,000. As mentioned, your portfolio would be worth $11,602 today. Over the five years subscribing to the newsletter, you would have paid approximately $745 in fees ($149 subscription fee over 5 years--note that the subscription rate in previous years may have been less). Your total cost basis would thus be $10,745. Taking fees into account, the newsletter's gain drops to 7.98%. While still better than the S&P 500, it's nothing to brag about.

Note that the time of this review is a factor. Had it been made before the recent market downturn, returns would have been much better. Because of the dividend focus, many of the newsletter's picks are in the financial sector, which has suffered a severe downturn. Many of these stocks have also lowered their dividends.

Feasibility

So, is it possible for an individual investor to keep up with all the Income Investor recommendations? Some stock gurus (e.g., Jim Cramer) recommend so many stocks that their performance doesn't matter, as retail investors don't have enough cash to make so many trades. What's the case with Income Investor?

As mentioned, there are two picks each month, and sometimes there is a bonus stock pick. The average is close to a total of two picks per month. Most people can probably devote a portion of their salary toward buying two stocks a month (this may be different if you're retired). Whether it's practical depends on broker commissions and amount invested. I go into this in greater detail in the cost section below.


Cost/Practicality

An Income Investor subscription is currently $149 per year. If you buy stocks based on the newsletter's recommendations, you should probably include brokerage commissions in the cost. If we assume $7 a trade, and you buy every recommendation (24 a year), that's an extra $168 a year (this does not include selling stocks, buying bonus picks, or buying previously recommended stocks that are "best buys now"). So, if you buy all the regular recommended stocks, the service will cost you $317 per year. If you buy the bonus picks, "best buys now," and sell your positions, you'll obviously have more broker commissions and your total cost in using the service will be higher.

Before going to practicality, it should be noted that brokerage costs can be reduced. For example, TradeKing has commissions of $4.95. Sharebuilder has $4 commissions for automated orders (the fee for selling, however, is $9.95), SogoTrade has $3 trades, and Zecco has free trades if your account is worth over $2,500.

So, I'll analyze the practicality with two examples. The first one will have the assumptions outlined above: $7 a trade, and you buy 24 stocks a year, selling none. The total cost here, as mentioned, is $317 a year.

For the second scenario, let's say you pay $0 in broker fees, and everything else is the same as above. Here, your total cost will be $149 a year.

As a rule of thumb, your total investment expenses shouldn't be more than 2% of the amount you're investing, as far as practicality is concerned. In the first scenario, you have to invest $15,850 a year to keep your expenses at 2%. In the second scenario, you have to invest $7,450 per year to keep your expenses at 2%.

Taking the second scenario, if you normally invest $7,450 or more a year and have at least the additional $149 a year for the costs, then the Income Investor service is practical for you. If you cannot afford to invest this much, for example, if you are unable to save at least $7,599 ($149 in costs plus $7,450 investment amount) a year the Income Investor service is not practical for you. Recall the actual gains on $10,000 invested above. While investing $7,450 makes Income Investor practical, subscription fees can dramatically lower your returns.

It may also be useful to compare Income Investor with what you'd pay for a similar service. Consider Jim Jubak's column. The updates on income investments are irregular, and there are other minor complications (see review here), but it's free. Jubak's dividend portfolio has averaged a gain of 13.5% annually through June 2008. If you pay for your trades, Jubak's portfolio is more cost effective too. The portfolio consists of less than a dozen positions. Motley Fool's Income Investor has over five times as many picks.

If you like diversification, Motley Fool's newsletter is for you. If you like the simplicity of a model portfolio (Jubak has a set amount of cash to use, with no fresh money) and are an income investor because you are retired, Jubak may be the better choice. Income Investor may offer a model portfolio in the future.

Bottom Line

Because of recent market turmoil, especially in the financial sector, investing in certificates of deposit or high yield savings accounts would probably have resulted in a better gain than Motley Fool's Income Investor newsletter (and the overall market). Depending on how much you would have invested, investing in the newsletter's picks would not have beaten the market due to costs.

There are free alternatives out there, that are just as good if not better. Consider Jim Jubak in this regard.

If you are looking for greater gains and are interested in Motley Fool, Stock Advisor is the better service.