Dividend Tree 17 March 2009 Commentary  Email This Post  Print This Post

Have you ever noticed that many times and perhaps on many occasions, we do things, or we respond certain situations, or the way we manage certain things, it may be reflecting how we really think. Even if we are not able to express it precisely we naturally tend to do things in a specific way. Conversely, it could also be due to our educational or experiential background.

The foundation of my educational background is in industrial/manufacturing engineering. Any industrial engineer in United States will know about a little book titled “The Goal”. It is written by Eliyahu Goldratt. It is written in a novel based story format. During the course of this story, Goldratt introduces the concept of “Theory of Constraints”. He intertwines the concepts with daily life events. When Goldratt introduced this book (and hence theory of constraints) in early 90s, management consultants recognized its significance and applied at hundreds of manufacturing organization across of board.

In his Theory of Constraints, Goldratt explains that in any manufacturing environment, there are three basic fundamental factors that are required to be addressed in tandem. If addressed properly, then only a manufacturing system will remain profitable or facilitate profitability. These three factors are (1) throughput; (2) inventory; and (3) operating expenses.

The notion here is maximize throughput, minimize inventory, and minimize operating expenses. These three are so intervened that one will affect the other. Throughput can be maximized if one buys an expense automated robotic system (higher operating expense), or throughput can be maximized by making them run continuously without starving them of any material (maximize inventory). So do you see, these are inversely related. What is significance of Theory of Constraints in dividend investing?

It does not have any bearing on dividend investing per se. However, it has lot of similarities with portfolio management process. The goal of my dividend portfolio management is deploy capital in a way that generates a sustainable higher cash flow as time progress.

Throughput: I would need to deploy capital that gives me continuously higher output i.e. higher cash flow. My dividend growth portfolio with dividend reinvestment is perfect way to continuously increase my cash flow.

Inventory: I would need to minimize my capital inventory, i.e. the non-performing capital lying around. A very good example is, when the dividends are cut or frozen, it tells me that my capital is tied down without give me cash flow. This is not a good scenario. I need to minimize this aspect within my portfolio.

Operating expenses: I would need to minimize my fees and commission. What better way than investing for long term, reinvesting at no fees, and low taxes on dividends. Could there have been any other way to minimize overall portfolio expenses?

So you see, my portfolio management process already reflects what perhaps is a widely used management practice. This not only gives me continued motivation, but also reinvigorates the thought that I am using the optimal management processes.

Keeping it simple!