Garmin doubles its dividend
Did you see what Garmin did this week? The company, which makes handheld GPS devices, doubled its dividend. It was a great move, and it scorched the short sellers in the stock. I'd like to talk about the move because I think it illustrates the legitimate way to take on short sellers, as opposed to the kind of things I normally see on Wall Street and in the press.
You've probably heard of "naked" short selling. Technically, naked short selling simply means a market maker has sold a stock short without actually finding the shares to borrow. He will do this expecting to find some shares soon to complete the trade. Some people are convinced these transactions are tantamount to a conspiracy to drive down the price of a stock. Whenever a stock is performing badly or something is wrong with a company, you'll almost always hear someone accusing short sellers of driving down the price by selling more shares than are actually available.
For example, how many times did you hear the Lehman Brothers CEO tell CNBC there was a conspiracy on Wall Street to put his firm out of business? Meanwhile, of course, the real reason so many people were shorting the stock was because it was common knowledge on trading desks across the Street that Lehman's accounting was completely bogus. Lehman was vastly inflating the value of its real estate assets and double counting its cash balances. As a result, it went bankrupt. Short selling the stock had nothing to do with these problems and did not change whatsoever the company's actual net worth.
Whenever I hear a CEO or analyst complaining about short sellers, it's a big red flag that he is probably trying to hide something. I mean, just consider the irony of the Lehman situation. Here's the CEO of an investment bank complaining about people trying to manipulate stock prices. Are you kidding me? It was Lehman Brothers' job to bull up stock prices on behalf of its IPO clients. Investment banks like Lehman are the ones who specialize in manipulating stocks.
The same thing is true for nearly every major business on Wall Street. Nobody complains about the people who openly and brazenly push stock prices higher. And yet, that's what ends up hurting investors. If a short seller were to manipulate prices lower, it would simply create a great opportunity for investors to buy stock at artificially low prices. How could that hurt anyone?
OK... with all of this in mind... let's get back to Garmin. Selling little GPS devices to consumers has been a phenomenally good business. Garmin's revenues have grown by about 30% a year for more than a decade – a truly astounding accomplishment. The company has excellent profit margins, too. Last year on nearly $3 billion in revenue, it produced more than $1 billion in cash from operations. That's a 30% cash profit margin. That's extraordinary. Few other large businesses in the world are this profitable. And the company has conservative management. Yes, it has completed a few acquisitions, but nothing too big and nothing that required any debt. Garmin is completely debt free.
You might think a company like this would sport a lofty share price. Nope. After peaking in late 2007 at more than $100 per share, Garmin sank into the low teens during the 2008 financial crisis. While the shares have rallied somewhat along with the rest of the market, Garmin remains far from its previous highs.
And the stock is cheap compared to other high-margin, high-growth consumer technology companies. Apple, for example, currently trades for 14 times its cash earnings. Garmin's stock trades at half this multiple.
Why is Garmin's stock trading at such a discounted valuation? Many investors believe its core product – those small GPS devices – are going to become obsolete. After all, they argue, GPS is now available for free on most cell phones. Garmin's price might also be down because short sellers have piled into the shares. Roughly 10% of all the shares outstanding have been sold short.
If you were Garmin's CEO and wanted to see your stock more accurately reflect its intrinsic value, what would you do? You could attack the short sellers as "evil" or "anti-American" etc. You could appeal to the SEC to ban short selling in your stock, which, incredibly, the investment banks did. Or you could simply prove to the market that the shorts' thesis is wrong and your shares are worth far more than the current price. How? By increasing the dividend. Garmin is a very profitable business. It has more than $1 billion in cash. It had been paying a 75-cent dividend, which it normally distributed in December.
But this week, Garmin's CEO suddenly announced the company would double its dividend and pay it immediately. Anyone short the stock as of April 30 will have to pay $1.50 per share to hold the position. Based on current prices, that's a 4.2% fee. Ouch.
So... what will happen from here? Well, it just depends on the results of the business. It doesn't matter how many people short the stock. With 200 million shares, it will cost Garmin $300 million per year to maintain this dividend. Last year, in a bad year, the company earned more than $1 billion in cash. I wouldn't be surprised to see Garmin double its dividend again next year – if its profits continue to grow anywhere near their historic clip (20% annually).
On the other hand, if Garmin's results decline, it might have to cut the dividend, which would surely hurt the stock price significantly as the market would see this as proof that the GPS device market is entering a permanent decline.
What's my bet? I wouldn't short the stock. I don't believe demand for handheld GPS devices is going to suddenly decline. Pricing on these things has fallen so far – you can buy a good GPS device for around $100 now – I think most people will be willing to buy a dedicated GPS device they simply leave in their car. I believe the devices have so much utility and they're so easy, people will prefer to use a dedicated GPS device despite competition from cell phones.
Oh... one more thing. At least one prominent investor seems to agree with me: Steve Cohen, the founder and head portfolio manager of the massive hedge fund SAC Capital. According to a recent SEC filing, SAC owns more than 2 million shares of Garmin.
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