CNBC presents the definitive report on the defining story of our time. CNBC correspondent David Faber investigates the origins of the global economic crisis, with first person accounts from home buyers, mortgage brokers, investment bankers and investors – most of whom let greed blind them, leading to the greatest financial collapse since the Great Depression.

Many investing magazines encourage investors to take the dividends received from a company and simply plow them back into the same company through a dividend reinvestment plan (DRIP). This, experts claim, allows shareholders to take advantage of the miracles of compounding.

Experts, however, fail to explain several pertinent points. First, re-investing dividends outside of a tax-free account incurs a tax. Second, companies sometimes hide their dubious financial condition by continuing to pay out or even raising their dividends while at the same time asking shareholders to purchase more stock through DRIP’s or common stock offerings. And last, most companies are not good enough to invest incremental capital at above average rates over the long term.

Tax
Given that investors pay taxes on dividends distributed by a company it seems silly that a company would pay a dividend only to ask for it back. Consider Jane: if, for example, she received $100 in dividends from Company Y she would pay tax of say $20 leaving her with $80 to reinvest back into the company. In this case the company receives $80 in new capital. If, on the other hand, Company Y didn’t pay a dividend they could invest the entire $100. Assuming Company Y can generate a return of 12% on incremental capital, the difference for Jane is significant. In the first scenario (the company paid the dividend), Jane’s pre-tax share of the returns on re-invested capital work out to $9.6 (12% of $80). However, in the second scenario – where retained the capital without paying a dividend – Jane earns $12 (12% of $100) – the difference in Jane’s proportional ownership interest are a mouth-watering 25%. The difference is from the DRIP tax.

Hiding dubious financial condition
Some companies, and I’m not naming names, can’t simultaneously fund dividends and replacement (or growth) capital expenditures. Companies under this predicament are often unwilling to suspend dividend payouts and suffer the inevitable share price reduction which would also make all of their options worthless. However, management can be creative instead. In some cases companies issue new equity while at the same time paying dividends. Shareholders partnering with management teams like this are likely to come up on the losing end.

Incremental capital investments
Companies cannot invest capital forever at growing or even consistently high rates of return. While there is something to be said for investing in companies you know and understand, shareholders must realize that at a certain point retained earnings serve the purposes of management more than shareholders. While management gains the social and compensation benefits associated with a larger company shareholders might be suffering. A company asking shareholders to ‘re-invest’ dividends is conceptually the same as a company asking for growth capital. That capital might allow the company to keep pace with the status quo (inflation) or allow it to expand.

If the company is asking you to give back your dividend money make sure they are using it wisely. Too many shareholders like ease and simplicity of a DRIP without thinking through what’s really happening.

Frontline offers an excellent story on the merger between Bank of American and Merrill Lynch.

Thanks to Ryan for sending us this link.

Bill, let me ask you about another one of your mentors. What’s the best advice Warren Buffett has ever given you?

Gates: Well, I’ve gotten a lot of great advice from Warren. I’d say one of the most interesting is how he keeps things simple. You look at his calendar, it’s pretty simple. You talk to him about a case where he thinks a business is attractive, and he knows a few basic numbers and facts about it. And [if] it gets less complicated, he feels like then it’s something he’ll choose to invest in. He picks the things that he’s got a model of, a model that really is predictive and that’s going to continue to work over a long-term period. And so his ability to boil things down, to just work on the things that really count, to think through the basics — it’s so amazing that he can do that. It’s a special form of genius.

If you’re getting too balled up with a lot of complicated things on your schedule, do you actually go back and think, What would Warren do?

Gates: Yeah, sure. I think Warren is so nice to everybody — how does he say no in a nice way? Or how does he think about priorities and have that explicitly in mind? And he turns down an unbelievable number of things, and yet everybody feels great about it. His grace in talking to people where he’s always saying, you know, “You probably understand this better than I do, but here’s how I messed it up when I first got involved in this.” You know, that’s a special talent, and I do find myself thinking, Hmm, how would Warren say this in a friendly fashion?

There was a case at the annual meeting where somebody asked a question about should you sell the stocks that have gone up and keep the ones that have not? And he sort of said, “No, you look at the value of the business.” And then Charlie [Munger] added, “He’s telling you your conceptual framework is all wrong.” Which is in fact what the answer had been, but there wasn’t one element of, “Hey, dummy …”

From the Fortune Article.

Isadore Sharp, the founder of Four Seasons, talks about how the company’s business philosophy is fairing during the economic downturn. A lot of companies could learn a lot from Issy.

Some key insights on the Four Seasons Business Philosophy (see Four Seasons The Story of Business Philosophy for more):

• It all comes down to value. What the customer considers to be of value they will buy.
• What we know and what our employees know is that everybody’s job is important [to setting us apart from our competitors.]
• Front line employees are key.
• Approach everything from the perspective of the customer — there is nothing we do that doesn’t have a value to the customer.
• Business is done on trust and belief.

Does Four Seasons have a sustainable competitive advantage? How would you try and compete head-to-head with them?