As frequent readers know, I believe that dividend investing is best done surgically, one stock at a time, with the stocks selected not only for yield, but also for dividend safety and company stability, with extra points for a proven culture and history of raising dividends regularly. Rising dividend investing is a long-term strategy, not one designed to skyrocket one month and plunge the next. It’s the tortoise of stock strategies.
That said, the most recent across-the-board information from S&P provides a background against which dividend strategies can be measured. And the news is good.
This table shows the S&P 500’s cash dividends paid out over the last 10 years.
Year Yield Companies Dividends Paid Change from
Paying (Billions) Prior Year
2009 2.0% 363 $195.61 -20.9%
2008 3.1% 372 $247.29 0.2%
2007 1.9% 390 $246.58 9.7%
2006 1.8% 383 $224.76 11.3%
2005 1.8% 386 $201.84 11.5%
2004 1.6% 377 $181.02 12.7%
2003 1.6% 370 $160.65 8.9%
2002 1.8% 351 $147.81 3.9%
2001 1.4% 351 $142.22 0.8%
2000 1.2% 372 $141.08 2.6%
As you can see, dividends crashed in 2009, falling almost 21%. Payments in Q1 2010 continued to decline, and they are expected to finish the quarter down 8% from Q1 2009. But those payments are mostly based on dividend rates set in place in 2009.
Going forward, S&P sees the indicated dividend rate for 2010 rising significantly. “Indicated rate” means the rate based on the most recent dividend declarations. Increases and initiations already announced in 2010 point to a significant increase in total dividend payments in 2010 compared to 2009. Through March 19, 68 of the 500 stocks have increased their payout rates and 7 more have initiated dividends, with just 1 decrease and 1 suspension. Compare that to Q1 last year, when there were 54 increases, 1 initiation, 40 decreases, and 6 suspensions.
Howard Silverblatt, Senior Index Analyst at S&P Indices, states that increases and initiations indicate confidence in future earnings abilities. S&P considers Q1 2009 to have been the worst quarter for dividends in history, so the year-over-year comparisons are not very challenging. Nevertheless, the early news this year is very positive. In my own Top 40 Dividend Stocks for 2010, 19 of the 40 stocks have already announced dividend increases for 2010, with no decreases.
Silverblatt goes on to note that April is usually a big month for dividend announcements. Four of the biggest payers--Exxon Mobil (XOM), IBM (IBM), Johnson & Johnson (JNJ), and Procter & Gamble (PG) are “up for renewal.” These four stocks, by themselves, account for about 11% of the S&P 500’s total payments. Interestingly, these stocks did not do badly at all in 2009 with respect to dividend increases. Respectively, they increased their indicated rates by 5%, 10%, 6.5%, and 10% last year. That illustrates why it’s a good idea to select your dividend stocks one by one. Even in an overall bad year like 2009, when total dividends fell 21%, these four posted average increases of 7.9%.
In 2009, 363 of the 500 stocks in the index paid dividends. To this point in 2010, 367 are dividend payers.
Tuesday, March 30, 2010
Tuesday, March 23, 2010
Is a Calm VIX Good News or Bad News?
VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options. A high value corresponds to a more volatile market. It is often referred to as the fear index. It represents one measure of the market's expectation of volatility over the next 30 day period.
A common interpretation of the VIX's value is that if it is above 30 or so, market participants are displaying fear of the market, and a market drop is likely in the making. Investors believe that a high value of VIX translates into a greater degree of market uncertainty, while a low value of VIX is consistent with greater stability. But another interpretation is that a low reading indicates complacency, low interest in the market, and therefore that the market might be ready for a fall, because there is little conviction on investors' parts.
Earlier today, I read the following from a well-respected analyst/pundit concerning the VIX: "The CBOE Volatility Index (VIX) fell to a low of 16.17 on Friday. The last time we saw a number on the VIX that low was in May of 2008, just prior to the fall from 13,000-plus to 10,970."
The implication was that the market is complacent, rolling over, and in his words, it’s time to “raise cash [sell stocks in anticipation of a decline] and be defensive.”
Is that quoted statement accurate? Yes. Is it misleading? Also yes.
It is true that the last time the VIX was at current levels was in 2008, just before the steepest part of the market crash that had begun in October, 2007. However, if you widen out the VIX chart to a 10-year look, you see a totally different pattern from the one implied by the statement above.
When the VIX hit 16 in 2008, it was rising, with increasing volatility. That presaged the market fall that the analyst referred to. But that moment in time had been preceded by a 3½-year period in which the VIX spent practically its entire time in the 10-20 range with low volatility. That period—from late 2003 to early 2007—coincided with a steady uptrend in the market. The Dow rose from about 9600 to about 13,000—about 35%--during that timeframe.
Currently, the VIX is falling, with decreasing volatility. It has dropped from a high of about 80 at the beginning of 2009 to its current level of about 16. The correct comparison is not between the VIX’s current level of 16 to the last time it was 16. The correct comparison is to the last time the VIX looked something like it does now. That would be mid-2002 to mid-2003, the last time the VIX was descending, with decreasing volatility, from a multi-year high to a level of 20 or below. The post-dot-com bear market, of course, ended in October, 2002, ushering in 5 years of a rising market that did not peak until October, 2007.
Disraeli said, “There are lies, damned lies, and statistics,” a saying that was popularized in the United States by Mark Twain. The statistic quoted at the beginning of this piece is the sort of thing they were talking about.
A common interpretation of the VIX's value is that if it is above 30 or so, market participants are displaying fear of the market, and a market drop is likely in the making. Investors believe that a high value of VIX translates into a greater degree of market uncertainty, while a low value of VIX is consistent with greater stability. But another interpretation is that a low reading indicates complacency, low interest in the market, and therefore that the market might be ready for a fall, because there is little conviction on investors' parts.
Earlier today, I read the following from a well-respected analyst/pundit concerning the VIX: "The CBOE Volatility Index (VIX) fell to a low of 16.17 on Friday. The last time we saw a number on the VIX that low was in May of 2008, just prior to the fall from 13,000-plus to 10,970."
The implication was that the market is complacent, rolling over, and in his words, it’s time to “raise cash [sell stocks in anticipation of a decline] and be defensive.”
Is that quoted statement accurate? Yes. Is it misleading? Also yes.
It is true that the last time the VIX was at current levels was in 2008, just before the steepest part of the market crash that had begun in October, 2007. However, if you widen out the VIX chart to a 10-year look, you see a totally different pattern from the one implied by the statement above.
When the VIX hit 16 in 2008, it was rising, with increasing volatility. That presaged the market fall that the analyst referred to. But that moment in time had been preceded by a 3½-year period in which the VIX spent practically its entire time in the 10-20 range with low volatility. That period—from late 2003 to early 2007—coincided with a steady uptrend in the market. The Dow rose from about 9600 to about 13,000—about 35%--during that timeframe.
Currently, the VIX is falling, with decreasing volatility. It has dropped from a high of about 80 at the beginning of 2009 to its current level of about 16. The correct comparison is not between the VIX’s current level of 16 to the last time it was 16. The correct comparison is to the last time the VIX looked something like it does now. That would be mid-2002 to mid-2003, the last time the VIX was descending, with decreasing volatility, from a multi-year high to a level of 20 or below. The post-dot-com bear market, of course, ended in October, 2002, ushering in 5 years of a rising market that did not peak until October, 2007.
Disraeli said, “There are lies, damned lies, and statistics,” a saying that was popularized in the United States by Mark Twain. The statistic quoted at the beginning of this piece is the sort of thing they were talking about.
Monday, March 22, 2010
Timing Outlook Advances to 9.0
(Note to subscribers: The e-mail subscription version you receive omits some formatting such as boldfacing and other cosmetic touches that make reading easier. Links are also harder to see in the subscription e-mail. If you want to view this post in its most pleasing format, just click on the title above, which is a link that will take you directly to this article in my Newsletter.)
1. Summary
After staying positive for 11 months, the Timing Outlook fell to a negative 4.4 six weeks ago, after 4 straight down weeks in the S&P 500 resulted in a market loss of 8%. But the market has rallied 9% since then, restoring positive configurations to all three indexes that I use here (S&P 500, Dow Jones Industrial, and NASDAQ). The Timing Outlook has risen steadily since the single negative reading, up to 9.0 today, which is positive.
A few reports ago, I began describing the weekly movements in the market, using this simple system of nomenclature: P stands for a positive week, N stands for a negative week, and 0 stands for no change. Here is what the market has done since the beginning of the new year: P-N-N-N-N-P-P-0-P-P-P. That’s 6 P’s, 4 N’s, and a 0.
The market went up 3% in the first week of the year; then fell 7% over the next 4 weeks; and since then has rallied almost 9%. Netted out for the year, the market is up 4% in 2010. It is up 71% since last March’s lowest point. Note that the one-year anniversary of the rally came and went on March 10.
The first earnings season of the year is almost over, with companies reporting on their Q4 2009 and full-year 2009 results. About 80% of companies have beaten earnings expectations, about the same number beat revenue expectations, and year-over-year earnings for many companies have become positive. Note that the year-over-year hurdle was easy to clear, as Q4 2008 had some of the worst earnings on record. Nevertheless, positive year-over-year comparisons are always good news, and the market’s slow, steady climb has reflected that.
As you know, the 8% sell-stops in my Capital Gains portfolio were hit during the 4-week down-trend (N-N-N-N) of January and early February. Those sales put the portfolio more than 80% in cash. But when the market reversed itself and started back up, I began slowly to move cash back into the market. The portfolio is now about 75% invested, and I will probably make 1-2 more purchases this week. As always, holdings in the Capital Gains portfolio are protected to the downside by sell stops. I am currently using rather tight 6% stops, as I have not gained complete confidence in this rally yet.
If you want to check the performance of the Capital Gains Portfolio portfolio since its creation in 2001, check out this page on my Web site. The portfolio is way ahead of the S&P 500 since its inception.
For a portfolio that does not utilize timing or sell-stops, but rather uses a dividend-growth approach, use the same link above to check out my Dividend Portfolio. For a description of the book on which the Dividend Portfolio is based, go to this page to read about THE TOP 40 DIVIDEND STOCKS FOR 2010: How to Generate Wealth or Income from Dividend Stocks.
2. Market Performance Since Last Outlook
(“now” figures are as of close Friday 3/19/10)
Last Outlook (3/7/10): 7.8 (positive)
S&P 500 last time (3/7/10): 1139
S&P 500 now: 1160 Change: +2%
S&P 500 at beginning of 2010: 1115
S&P 500 now: 1160 Change in 2010: +4%
S&P 500 at close 3/9/09: 677 (beginning of 2009-10's bull market)
S&P 500 now: 1160 Change since 3/9/09: +71%
3. Indicators in Detail
• Conference Board Index of Leading Economic Indicators: A new report last week showed the 11th consecutive monthly increase. The string of increases suggests an improving economy, which is usually good for the stock market. Positive. +10
• Fed Funds Rate: No change.The Fed Funds rate remains near zero, so this indicator stays positive. +10
• S&P 500 Market Valuation: Correspondence with Morningstar paid off, they have corrected their display of the index’s P/E based on operating earnings. The current reading is 19.3, which is in the fairly valued, neutral zone. +5
• Morningstar’s Market Valuation Graph. This indicator has been meandering small distances around 1.0 (“fair value”) since late July, 2009. It has been going up for the past several weeks, along with the market itself, but staying within the “fairly valued” band of 0.9 to 1.1. It currently stands at 1.05, up from 1.04 last time. Neutral. +5
• S&P 500 Short Term Technical Trend: The rise in the market since early February (P-P-0-P-P) has pulled the S&P 500’s chart back into its most favorable configuration: Index > 20-day SMA > 50-day SMA > 200-day SMA. This short-term technical indicator uses the index’s relationship with the two shorter simple moving averages (SMA). The relationship is positive: The index has pulled the 20-day SMA above the 50-day SMA. Positive. +10
• S&P 500 Medium Term Technical Trend: This trend uses the two longer SMAs. It remains positive. +10
• DJIA Short Term Technical Trend: The Dow has the same configuration as the S&P 500, so this indicator and the Dow's medium-term indicator are both positive. +10
• DJIA Medium Term Technical Trend: Positive. +10
• NASDAQ Short Term Technical Trend: The NASDAQ chart has the same configuration as the other two. Positive. +10
• NASDAQ Medium Term Technical Trend: Positive. +10
TOTAL POINTS: 90 NEW READING: 90 / 10 = 9.0 = POSITIVE
1. Summary
After staying positive for 11 months, the Timing Outlook fell to a negative 4.4 six weeks ago, after 4 straight down weeks in the S&P 500 resulted in a market loss of 8%. But the market has rallied 9% since then, restoring positive configurations to all three indexes that I use here (S&P 500, Dow Jones Industrial, and NASDAQ). The Timing Outlook has risen steadily since the single negative reading, up to 9.0 today, which is positive.
A few reports ago, I began describing the weekly movements in the market, using this simple system of nomenclature: P stands for a positive week, N stands for a negative week, and 0 stands for no change. Here is what the market has done since the beginning of the new year: P-N-N-N-N-P-P-0-P-P-P. That’s 6 P’s, 4 N’s, and a 0.
The market went up 3% in the first week of the year; then fell 7% over the next 4 weeks; and since then has rallied almost 9%. Netted out for the year, the market is up 4% in 2010. It is up 71% since last March’s lowest point. Note that the one-year anniversary of the rally came and went on March 10.
The first earnings season of the year is almost over, with companies reporting on their Q4 2009 and full-year 2009 results. About 80% of companies have beaten earnings expectations, about the same number beat revenue expectations, and year-over-year earnings for many companies have become positive. Note that the year-over-year hurdle was easy to clear, as Q4 2008 had some of the worst earnings on record. Nevertheless, positive year-over-year comparisons are always good news, and the market’s slow, steady climb has reflected that.
As you know, the 8% sell-stops in my Capital Gains portfolio were hit during the 4-week down-trend (N-N-N-N) of January and early February. Those sales put the portfolio more than 80% in cash. But when the market reversed itself and started back up, I began slowly to move cash back into the market. The portfolio is now about 75% invested, and I will probably make 1-2 more purchases this week. As always, holdings in the Capital Gains portfolio are protected to the downside by sell stops. I am currently using rather tight 6% stops, as I have not gained complete confidence in this rally yet.
If you want to check the performance of the Capital Gains Portfolio portfolio since its creation in 2001, check out this page on my Web site. The portfolio is way ahead of the S&P 500 since its inception.
For a portfolio that does not utilize timing or sell-stops, but rather uses a dividend-growth approach, use the same link above to check out my Dividend Portfolio. For a description of the book on which the Dividend Portfolio is based, go to this page to read about THE TOP 40 DIVIDEND STOCKS FOR 2010: How to Generate Wealth or Income from Dividend Stocks.
2. Market Performance Since Last Outlook
(“now” figures are as of close Friday 3/19/10)
Last Outlook (3/7/10): 7.8 (positive)
S&P 500 last time (3/7/10): 1139
S&P 500 now: 1160 Change: +2%
S&P 500 at beginning of 2010: 1115
S&P 500 now: 1160 Change in 2010: +4%
S&P 500 at close 3/9/09: 677 (beginning of 2009-10's bull market)
S&P 500 now: 1160 Change since 3/9/09: +71%
3. Indicators in Detail
• Conference Board Index of Leading Economic Indicators: A new report last week showed the 11th consecutive monthly increase. The string of increases suggests an improving economy, which is usually good for the stock market. Positive. +10
• Fed Funds Rate: No change.The Fed Funds rate remains near zero, so this indicator stays positive. +10
• S&P 500 Market Valuation: Correspondence with Morningstar paid off, they have corrected their display of the index’s P/E based on operating earnings. The current reading is 19.3, which is in the fairly valued, neutral zone. +5
• Morningstar’s Market Valuation Graph. This indicator has been meandering small distances around 1.0 (“fair value”) since late July, 2009. It has been going up for the past several weeks, along with the market itself, but staying within the “fairly valued” band of 0.9 to 1.1. It currently stands at 1.05, up from 1.04 last time. Neutral. +5
• S&P 500 Short Term Technical Trend: The rise in the market since early February (P-P-0-P-P) has pulled the S&P 500’s chart back into its most favorable configuration: Index > 20-day SMA > 50-day SMA > 200-day SMA. This short-term technical indicator uses the index’s relationship with the two shorter simple moving averages (SMA). The relationship is positive: The index has pulled the 20-day SMA above the 50-day SMA. Positive. +10
• S&P 500 Medium Term Technical Trend: This trend uses the two longer SMAs. It remains positive. +10
• DJIA Short Term Technical Trend: The Dow has the same configuration as the S&P 500, so this indicator and the Dow's medium-term indicator are both positive. +10
• DJIA Medium Term Technical Trend: Positive. +10
• NASDAQ Short Term Technical Trend: The NASDAQ chart has the same configuration as the other two. Positive. +10
• NASDAQ Medium Term Technical Trend: Positive. +10
TOTAL POINTS: 90 NEW READING: 90 / 10 = 9.0 = POSITIVE
Wednesday, March 17, 2010
How I Tell If the Market Is "Going Up"
Over the past couple of years, I have written articles about whether the stock market has bottomed out or topped out, meaning has it hit an inflection point for awhile? I also wrote several articles about why I thought last year's rally was sustainable, which turned out to be accurate. I wrote an article a few weeks ago that opined that I thought the market had probably topped out for awhile after it hit 1150 and then fell backward. I was wrong: After dropping more than 8% and hitting my sell stops, the market reversed back and resumed a slow upward trend. It passed through 1150 a couple of days ago, and it finished at 1166 today (Wednesday).
And I continue to write the bi-weekly Timing Outlook articles that use a formulaic system to project the market's likely direction for 2-4 weeks. Those, while of course not infallible, have had a high batting average.
One point I have not nailed down: If my sell-stops get hit, and therefore my Capital Gains portfolio has cash rather than being 100% invested, how do I know whether and when to start re-investing the money? I have been vague about this, simply stating that I like to see the market "going up" for 2-3-4 weeks before I conclude that it may be in an "investable uptrend."
In this article, I want to get more specific about that. What follows is still a hypothesis, not a prescription. But here is what I have been doing.
1. I start with Ned Davis’ definitions of a bull market. (Ned Davis Research is a respected, fact-based research outfit.) Their two definitions of a bull market are:
To my eyes, the second definition is a little lenient. So I toughened it up by requiring a 20% rise rather than a 13% rise over the same time period. I chose 20% because it matches the common definition of bull market (a 20% rise in the market). So my modified "B" bull market is defined like this:
I answer this by taking the bull market definitions (A and B) and slicing them into shorter time periods. I also add a requirement: that 2/3 of the trading days have to be “up” days. This prevents one gargantuan "up" day from creating an "investable" market all by itself. What results is this:
For risk management, I am using pretty tight sell stops, around 6% on all holdings. As you probably know by now, I use sell stops on all holdings in my Capital Gains portfolio. I do not use them in my Dividend Portfolio, preferring other approaches to risk management in a dividend growth strategy.
And I continue to write the bi-weekly Timing Outlook articles that use a formulaic system to project the market's likely direction for 2-4 weeks. Those, while of course not infallible, have had a high batting average.
One point I have not nailed down: If my sell-stops get hit, and therefore my Capital Gains portfolio has cash rather than being 100% invested, how do I know whether and when to start re-investing the money? I have been vague about this, simply stating that I like to see the market "going up" for 2-3-4 weeks before I conclude that it may be in an "investable uptrend."
In this article, I want to get more specific about that. What follows is still a hypothesis, not a prescription. But here is what I have been doing.
1. I start with Ned Davis’ definitions of a bull market. (Ned Davis Research is a respected, fact-based research outfit.) Their two definitions of a bull market are:
- A: Market rises 30% over 50 calendar days (which equals about 36 trading days or about 7 weeks)
- B: Market rises 13% over 155 calendar days (about 110 trading days or 22 weeks)
To my eyes, the second definition is a little lenient. So I toughened it up by requiring a 20% rise rather than a 13% rise over the same time period. I chose 20% because it matches the common definition of bull market (a 20% rise in the market). So my modified "B" bull market is defined like this:
- B: Market rises 20% over 155 calendar days (about 110 trading days or 22 weeks)
I answer this by taking the bull market definitions (A and B) and slicing them into shorter time periods. I also add a requirement: that 2/3 of the trading days have to be “up” days. This prevents one gargantuan "up" day from creating an "investable" market all by itself. What results is this:
- 2 weeks: A: 9% rise with at least 7 positive days (out of 10 trading days). "B" produces no signal, because the rise required would be less than 2%, which seems meaningless.
- 3 weeks: A: 12% rise with at least 10 positive days (out of 15). B: 3% rise with at least 10 positive days (out of 15). Since B is more lenient than A, it makes A moot.
- 4 weeks: A remains moot. B: 4% rise with at least 14 positive days (out of 20).
- 5 weeks: A remains moot. B: 5% rise with at least 18 positive days (out of 25)
- 9% rise over two weeks, with at least 7/10 days positive
- 3% rise over 3 weeks, with at least 10/15 days positive
- 4% rise over 4 weeks, with at least 14/20 days positive
- 5% rise over 5 weeks, with at least 17/25 days positive
- Etc.
For risk management, I am using pretty tight sell stops, around 6% on all holdings. As you probably know by now, I use sell stops on all holdings in my Capital Gains portfolio. I do not use them in my Dividend Portfolio, preferring other approaches to risk management in a dividend growth strategy.
Sunday, March 7, 2010
Timing Outlook Advances
1. Summary
After staying positive for 11 months, the Timing Outlook fell to a negative 4.4 four weeks ago after 4 straight down weeks in the S&P 500 resulted in a loss of 8%. But a 7% rally in the markets since then has pulled the Timing Outlook up to 7.8, which is positive.
Last time, I noted that the market had basically moved sideways since October. Now let’s just focus in on the past 9 weeks. If P stands for a positive week, N stands for a negative week, and 0 stands for no change, here is what the market has done since the beginning of the new year: P-N-N-N-N-P-P-0-P. That’s 4 P’s, 4 N’s, and a 0. The S&P 500 has gone up 2% over that timespan, but the last 4 weeks have seen a 7% rise.
Last time, I asked the question, what kind of market are we in?
1. A continuing bull market that began last March, went through an 8% “correction,” and is now going up again? Or…
2. A new bear that began with the 4-week decline? Or…
3. A range-bound, trend-less market that might just go up and down in relatively small amounts for an indeterminate period of time?
After the 4 consecutive down weeks, during which investor sentiment seemed sullen, investor sentiment seemed to turn more positive. Perhaps it was the almost-consistently good news from earnings season. About 80% of companies that have reported have beaten earnings expectations, about the same number beat revenue expectations, and year-over-year earnings for many companies have actually been positive. Please note, on the latter point, that the year-ago comparisons are a low hurdle to clear, as Q4 2008 had negative earnings for one of the few times ever. That’s the quarter when many banks took massive write-downs in the midst of the credit crisis. Nevertheless, positive year-over-year comparisons are always good news.
It is still too soon to tell whether #1, 2, or 3 will answer “what kind of market are we in?” The positive action of the past 4 weeks seems to render choice #2 (new bear market) less likely than the others. If the markets keep reacting positively to positive news, and not too negatively to negative news, I’d say that the likely choice is #1—still in the bull market that began last March. But overall, as I said, it’s too early to tell.
I reported several weeks ago that the 8% sell-stops in my Capital Gains portfolio had been hit, putting the portfolio more than 80% in cash. But with two straight positive Timing Outlooks and a solid 4-week rise in all the major indexes, I have decided to cautiously put some money back into the market. I made two purchases last week that put about 20% of the portfolio’s cash back into the market, and I will make one or two more purchases this coming week if things continue to trend positively. As always, these purchases are protected to the downside by sell stops.
If you want to check the performance of the Capital Gains Portfolio portfolio since its creation in 2001, check out this page on my Web site. The portfolio is well ahead of the S&P 500 since its inception.
For a portfolio that does not utilize timing or sell-stops, but rather uses dividend-paying stocks and basically a buy-and-monitor approach, use the same link above to check out my Dividend Portfolio. For a description of the book on which the Dividend Portfolio is based, go to this page to read about The Top 40 Dividend Stocks for 2010: How to Generate Wealth or Income from Dividend Stocks.
2. Market Performance Since Last Outlook
(“now” figures are as of close Friday 3/5/10)
Last Outlook (2/21/10): 6.1 (positive)
S&P 500 last time (2/21/10): 1109
S&P 500 now: 1139 Change: +3%
S&P 500 at beginning of 2010: 1115
S&P 500 now: 1139 Change in 2010: +2%
S&P 500 at close 3/9/09: 677 (beginning of 2009's bull market)
S&P 500 now: 1139 Change since 3/9/09: +68%
S&P 500 at peak 1/19/10: 1150 (possible beginning of bear market)
S&P 500 now: 1139 Change since 1/19/10: -1%
3. Indicators in Detail
• Conference Board Index of Leading Economic Indicators: The report issued 2/18/10 showed the 10th consecutive monthly increase. Because this index tracks data that tend to lean in advance of the business cycle, a string of increases suggests an improving economy, which is usually good for the stock market. Positive. +10
• Fed Funds Rate: No change. Two weeks ago, the Fed’s raising of the “discount rate” from 0.5% to 0.75% seemed to be absorbed by the market with little concern. The market has risen 3% since then. The Fed Funds rate itself remains near zero, so this indicator stays positive. +10
• S&P 500 Market Valuation: I have been corresponding with Morningstar about this number, and they have acknowledged an error in their display of the data that I had been using. I still do not have a satisfactory substitute. On their page for the S&P 500 index itself, Morningstar reports the index’s P/E based on “prospective earnings,” but to use that, I would have to recalibrate what the bands are for the index being undervalued, overvalued, or fairly valued. So again for this report, I will drop this factor from the calculation. NA
• Morningstar’s Market Valuation Graph. This indicator has been meandering small distances around 1.0 (“fair value”) since late July, 2009. It has been going up for the past several weeks, along with the market itself, but staying within the “fairly valued” band of 0.9 to 1.1. It currently stands at 1.04. Neutral. +5
• S&P 500 Short Term Technical Trend: This indicator looks at the index’s relationship with two key moving averages, the 20-day and 50-day simple moving averages (SMA). During the 4 down weeks in January, the S&P 500 lost about 8% of its value, fell through both its 20-day and 50-day SMAs), and pulled the 20-day SMA down through the 50-day SMA. Then the market reversed itself. After a four-week recovery, the index has risen 7% and gone back up through both SMAs, although it has not yet pulled the 20-day SMA obove the 50-day. So we have Index > 50-day SMA > 20-day SMA. The back-and-forth movement of the index renders this short-term indicator ambiguous and neutral. +5
• S&P 500 Medium Term Technical Trend: This trend, which uses the 50-day and 200-day SMAs, turns positive. The index has moved well above its 50-day SMA, which in turn has remained above the 200-day SMA through these back-and-forth weeks. Positive. +10
• DJIA Short Term Technical Trend: Has the same configuration as the S&P 500 short-term trend. Neutral. +5
• DJIA Medium Term Technical Trend: Same pattern as the S&P 500. Positive. +10
• NASDAQ Short Term Technical Trend: Same as the other two. Neutral. +5
• NASDAQ Medium Term Technical Trend: Same as the other two. Positive. +10
TOTAL POINTS: 70 NEW READING: 70 / 9 = 7.8 = POSITIVE
After staying positive for 11 months, the Timing Outlook fell to a negative 4.4 four weeks ago after 4 straight down weeks in the S&P 500 resulted in a loss of 8%. But a 7% rally in the markets since then has pulled the Timing Outlook up to 7.8, which is positive.
Last time, I noted that the market had basically moved sideways since October. Now let’s just focus in on the past 9 weeks. If P stands for a positive week, N stands for a negative week, and 0 stands for no change, here is what the market has done since the beginning of the new year: P-N-N-N-N-P-P-0-P. That’s 4 P’s, 4 N’s, and a 0. The S&P 500 has gone up 2% over that timespan, but the last 4 weeks have seen a 7% rise.
Last time, I asked the question, what kind of market are we in?
1. A continuing bull market that began last March, went through an 8% “correction,” and is now going up again? Or…
2. A new bear that began with the 4-week decline? Or…
3. A range-bound, trend-less market that might just go up and down in relatively small amounts for an indeterminate period of time?
After the 4 consecutive down weeks, during which investor sentiment seemed sullen, investor sentiment seemed to turn more positive. Perhaps it was the almost-consistently good news from earnings season. About 80% of companies that have reported have beaten earnings expectations, about the same number beat revenue expectations, and year-over-year earnings for many companies have actually been positive. Please note, on the latter point, that the year-ago comparisons are a low hurdle to clear, as Q4 2008 had negative earnings for one of the few times ever. That’s the quarter when many banks took massive write-downs in the midst of the credit crisis. Nevertheless, positive year-over-year comparisons are always good news.
It is still too soon to tell whether #1, 2, or 3 will answer “what kind of market are we in?” The positive action of the past 4 weeks seems to render choice #2 (new bear market) less likely than the others. If the markets keep reacting positively to positive news, and not too negatively to negative news, I’d say that the likely choice is #1—still in the bull market that began last March. But overall, as I said, it’s too early to tell.
I reported several weeks ago that the 8% sell-stops in my Capital Gains portfolio had been hit, putting the portfolio more than 80% in cash. But with two straight positive Timing Outlooks and a solid 4-week rise in all the major indexes, I have decided to cautiously put some money back into the market. I made two purchases last week that put about 20% of the portfolio’s cash back into the market, and I will make one or two more purchases this coming week if things continue to trend positively. As always, these purchases are protected to the downside by sell stops.
If you want to check the performance of the Capital Gains Portfolio portfolio since its creation in 2001, check out this page on my Web site. The portfolio is well ahead of the S&P 500 since its inception.
For a portfolio that does not utilize timing or sell-stops, but rather uses dividend-paying stocks and basically a buy-and-monitor approach, use the same link above to check out my Dividend Portfolio. For a description of the book on which the Dividend Portfolio is based, go to this page to read about The Top 40 Dividend Stocks for 2010: How to Generate Wealth or Income from Dividend Stocks.
2. Market Performance Since Last Outlook
(“now” figures are as of close Friday 3/5/10)
Last Outlook (2/21/10): 6.1 (positive)
S&P 500 last time (2/21/10): 1109
S&P 500 now: 1139 Change: +3%
S&P 500 at beginning of 2010: 1115
S&P 500 now: 1139 Change in 2010: +2%
S&P 500 at close 3/9/09: 677 (beginning of 2009's bull market)
S&P 500 now: 1139 Change since 3/9/09: +68%
S&P 500 at peak 1/19/10: 1150 (possible beginning of bear market)
S&P 500 now: 1139 Change since 1/19/10: -1%
3. Indicators in Detail
• Conference Board Index of Leading Economic Indicators: The report issued 2/18/10 showed the 10th consecutive monthly increase. Because this index tracks data that tend to lean in advance of the business cycle, a string of increases suggests an improving economy, which is usually good for the stock market. Positive. +10
• Fed Funds Rate: No change. Two weeks ago, the Fed’s raising of the “discount rate” from 0.5% to 0.75% seemed to be absorbed by the market with little concern. The market has risen 3% since then. The Fed Funds rate itself remains near zero, so this indicator stays positive. +10
• S&P 500 Market Valuation: I have been corresponding with Morningstar about this number, and they have acknowledged an error in their display of the data that I had been using. I still do not have a satisfactory substitute. On their page for the S&P 500 index itself, Morningstar reports the index’s P/E based on “prospective earnings,” but to use that, I would have to recalibrate what the bands are for the index being undervalued, overvalued, or fairly valued. So again for this report, I will drop this factor from the calculation. NA
• Morningstar’s Market Valuation Graph. This indicator has been meandering small distances around 1.0 (“fair value”) since late July, 2009. It has been going up for the past several weeks, along with the market itself, but staying within the “fairly valued” band of 0.9 to 1.1. It currently stands at 1.04. Neutral. +5
• S&P 500 Short Term Technical Trend: This indicator looks at the index’s relationship with two key moving averages, the 20-day and 50-day simple moving averages (SMA). During the 4 down weeks in January, the S&P 500 lost about 8% of its value, fell through both its 20-day and 50-day SMAs), and pulled the 20-day SMA down through the 50-day SMA. Then the market reversed itself. After a four-week recovery, the index has risen 7% and gone back up through both SMAs, although it has not yet pulled the 20-day SMA obove the 50-day. So we have Index > 50-day SMA > 20-day SMA. The back-and-forth movement of the index renders this short-term indicator ambiguous and neutral. +5
• S&P 500 Medium Term Technical Trend: This trend, which uses the 50-day and 200-day SMAs, turns positive. The index has moved well above its 50-day SMA, which in turn has remained above the 200-day SMA through these back-and-forth weeks. Positive. +10
• DJIA Short Term Technical Trend: Has the same configuration as the S&P 500 short-term trend. Neutral. +5
• DJIA Medium Term Technical Trend: Same pattern as the S&P 500. Positive. +10
• NASDAQ Short Term Technical Trend: Same as the other two. Neutral. +5
• NASDAQ Medium Term Technical Trend: Same as the other two. Positive. +10
TOTAL POINTS: 70 NEW READING: 70 / 9 = 7.8 = POSITIVE
Wednesday, February 24, 2010
Why I Love Dividends
Recently, I wrote an article for another investing site in defense of dividend investing. It was in response to several articles with titles like “Why I Hate Dividends” and “The Dumbness of Dividends.” I have modified my article for this site.
The Case Against Dividends: The anti-dividend articles, when combined, made the following case against dividends:
1. Retained earnings produce growth. Money sent out as dividends cannot contribute to growth.
2. Retained earnings, if not re-invested for growth, are better spent in share repurchases than in dividends.
3. Share repurchases and reinvestments in the business should fuel future price appreciation. Dividends do not. In fact, dividends reduce price appreciation.
4. Dividends reduce the value of the underlying shares by the amount of the dividend.
5. Studies do not find that dividend stocks “do better” than non-dividend-paying stocks.
6. It is more tax efficient to generate income from selling shares than from dividends.
7. Dividends’ appeal lies largely with uneducated shareholders. Companies use dividends to bribe shareholders and to exploit shareholder ignorance.
8. Would you want Warren Buffett to distribute dividends rather than keep doing what he’s been doing for decades (Berkshire Hathaway does not issue dividends)?
The Case for Dividends: Here, I am not trying to show that dividend stocks are always the best investment. But I am trying to show that dividend stocks can be the basis of a very intelligent and successful investment strategy. Dividend stocks are not just for retirees or clueless investors.
The Dual Nature of Dividend Stocks: Many investors think of stocks as assets that you trade with a focus on price: Buy low, sell high. If you mention income production, they think of bonds. But dividend-paying stocks are instruments with the power both to produce income and to rise in price. A good dividend stock is an equity security like all others, but with unique income characteristics.
What I call the Sensible Dividend Investor is not stupid or ignorant. But he or she often comes to see stocks differently from growth investors. Stocks become like cash machines that generate streams of income. Dividend investors do not lose all interest in the price of their shares, but price doesn’t matter as much. If prices fall, the dividends keep coming. Price declines often present attractive buying opportunities for those who are still in the wealth-accumulating stage of their lives.
The idea that dividends are the principal reason for owning a stock is not a new concept. In 1934, Benjamin Graham and David Dodd wrote in their classic Security Analysis, "The prime purpose of a business corporation is to pay dividends to its owners [emphasis added].” This statement is more than a quaint reflection of its time. It is a fundamental view of what owning shares in a company is all about, as valid today as 75 years ago.
Stock Prices Tell Only Half the Story: The total return from stocks is comprised of two elements: price appreciation and dividends. Studies show that dividends have accounted for half or more of the total return of the stock market over very long terms. Despite this, there is no widely publicized “dividend index” that gets the coverage given every day ro the Dow, S&P 500, and NASDAQ indexes, even though those reflect price changes only.
As to price appreciation: A company creates value by generating profits. It ingests investors’ capital and/or borrowed money to get started, and then it utilizes the skills of its people, research, development, manufacturing, marketing, and other functions to bring in more money than it spends. The net pileup of profits and assets, and the company’s ability to utilize those to bring in ever-larger earnings, increase the enterprise’s value over time.
In turn, the company’s stock price goes up if the market recognizes the increased value of the company. Historically, through a wisdom-of-crowds “price discovery” process, investors have tended to recognize and pay for increased earnings capabilities. They do this by placing an appropriate multiple on a company’s earnings per share. Over long periods of time, the multiple has averaged out around 15-16. That is, if a company makes $1 per share profit, its price will hang around $15 or $16. Sometimes, prices rise or fall because the market places a higher or lower multiple on the shares. The multiple thus reflects investor sentiment toward the stock, or toward the entire stock market.
The Dividend Half of the Story: First of all, note the obvious: Dividends are always positive—there is no such thing as a negative dividend. As to the long-term record of dividend stocks, I will focus on just two studies to save space.
• Wharton Professor Jeremy Siegel’s research attributes 97% of the stock market’s total return from 1871 to 2003 to re-invested dividends, and he also states that from 1926 to 2004, reinvestment of dividends accounted for 46% of all stock market return after inflation.
• In a February, 2009 article, “Follow the Juicy Dividends,” BusinessWeek cited Ned Davis research showing that stocks with at least five years of dividend growth outperformed the S&P 500 every year from 1972 to 2008. The study showed these annual total returns:
o Dividend Cutters or Eliminators: 0.5%
o Non-Dividend Payers: 0.7%
o S&P 500: 6.2%
o Dividend Payers with No Change in Dividends: 6.2%
o Dividend Growers and Initiators: 8.7%
The Share-Buyback Red Herring: One of the most-cited reasons against dividends is that shareholders are better off if the company uses that money to buy back shares of itself. Share repurchase programs are not regular programs. They are not predictable as to size or frequency. Some share repurchases are not completed after their announcement. In hard times, most companies will suspend a share buyback program before they touch the dividend.
Often companies pay top dollar for their shares. They don’t “buy low.” Figures from S&P show that few companies repurchased their shares in 2002, the bottom of the post-internet-bubble bear market. But when stock prices were increasing from 2003 to 2007, buybacks became rampant, peaking in Q3 2007, simultaneously with the market’s peak. Then in 2008-2009, when the next bear market hit, buybacks slowed dramatically. This phenomenon appears in every market cycle. USA Today ran a recent article in which it reported that S&P analysts studied stock repurchases from Jan. 1, 2006, through June 2007. They found that a third of all companies took losses from their purchases; three-quarters of the companies that bought back shares lagged behind the S&P 500 for the period; and the most aggressive buyers of their own stock were some of the worst performers.
The Taxation Issue: You must pay taxes on dividends. However, the Federal dividend tax rate of 15 percent makes it one of the least-taxed forms of income available. (Note: The 15 percent tax rate on dividends is due to expire at the end of 2010. Note also that dividends from REITs and certain other special corporate forms are taxed at your marginal tax rate, because their profits are not taxed at the corporate level.) Of course, if you hold your dividend stocks in a tax-deferred account, the normal tax benefits of such accounts apply to the dividends.
It is true that share repurchases are not taxed. But if you want to get the money from share price growth, you must sell some of the shares to get it. Your gain will be taxed at either the long-term or short-term capital gains rate. The Federal long-term rate is 15 percent, the same as with dividends.
Sometimes, investors become too focused on tax considerations. The primary appeal of dividends has never been based on a tax break; that is of recent origin anyway. The chief appeal of dividends is the opportunity to receive cash returns from stocks that are always positive, keep increasing, and are independent of price fluctuations.
Characteristics of the Best Dividend Companies: The best dividend companies have a strong culture of increasing the dividend annually if at all possible. Many have been increasing their dividends for decades. The top dividend-paying companies tend to have strong balance sheets and to handle cash conservatively. Most of them have rock-solid business models and are veritable cash machines. The best dividend-paying companies generate enough cash to fund both growth and dividends.
Dividends cannot be faked, unlike earnings. Paying dividends takes cash out of the hands of management and forces management to handle the remaining cash more carefully. As noted in the November 24, 2008 edition of Fortune, “Companies that retain most or all of their earnings frequently squander those profits. CEOs waste those retained earnings on ‘empire building’ via overpriced acquisitions. Amazingly, companies that pay big dividends actually grow their earnings far faster than those that reinvest most or all of their profits. Paying dividends imposes discipline; it makes the top brass far more careful in deploying scarce cash.”
Dividend stocks tend to attract a different constituency from growth companies. Many shareholders prefer a steady return and a predictable, reliable dividend flow. Investors following a dividend-growth strategy are less likely to sell their shares in response to short-term difficulties. The dividend stream is generally independent of price changes in the stock itself. Shareholders are, in a sense, set free from constant concern about the stock’s price. Dividend investing is a strategy for the long haul. The major attraction is not to make money from price increases, although that is delightful. The major attraction is the dividend itself.
The Power of Rising Dividends: Well-chosen dividend stocks increase their dividends every year, and those can be re-invested to accelerate the process of building wealth. Even if not re-invested, rising dividends obviously deliver increasing income. In contrast to growth stocks, dividend stocks do not have to be traded to realize these benefits.
The best dividend stocks usually grow their dividends at a higher rate than inflation, unlike the fixed dividend payment from most bonds. If you own shares in a dividend-paying company that increases its dividends, your yield on cost (that is, the yield on your original investment) goes up. This happens even though the current yield stays the same. It’s simple math. No matter how the stock’s price changes over the coming years, your personal yield (= yield on cost) will always be based on what you paid originally.
Over time, your personal yield will surpass the 10%-11% long term total average return of the stock market itself, just from the dividends alone. This is the most powerful aspect of dividend stocks. The process can be accelerated, of course, by re-investing the dividends and letting them compound.
This contrasts sharply with bonds. Bonds are fixed income investments. We can easily see the ways that they are “fixed”: Their term is fixed; their “coupon,” or rate of return, is fixed; and their nominal worth at the end of the term is fixed. You get back what you originally paid—in dollars that have been eroded by inflation.
Take a look at this table of returns for a terrific dividend company, Automatic Data Processing (ADP):
Year 2005 2006 2007 2008 2009
Price Return +5% +9% +3% -9% +9%
Dividend $0.65 0.79 0.98 1.20 1.33
Div. Increase +22% +24% +22% +11%
Note how the price return varies each year, including going negative in 2008. Also note how the dividend just keeps marching up each year. ADP has been raising its dividend for 35 straight years now, yields about 3.5% to new purchasers (much more than that to investors who have owned it for years), and is one of only four US non-financial companies with an AAA credit rating. Another of the four AAA-rated companies is Johnson & Johnson (JNJ), also a top dividend stock.
Of course, there is risk to any company’s dividend. If a company suffers dramatic financial misfortune, and its profits fall or disappear, so can its dividends. Financial calamity will trump any company’s desire and ability to keep sending out dividends. Dividends are not guaranteed. But for well-selected dividend payers, that risk is usually small.
What About Buffett? Do I want Berkshire Hathaway to pay dividends? Personally, I could not care less. I believe that every company has an optimum level of dividend payout that the company discovers over time, as it matures. For new companies, the optimum rate is almost always zero. They need all the cash they can get to grow from corporate infancy through adolescence and into adulthood. For some mature companies, this level is still zero, because of its business model. Berkshire Hathaway certainly has enough cash to pay a dividend, and who knows, they may choose to do so some day, just as Microsoft did a few years ago. But Buffett does OK with a zero dividend, and that’s fine with me.
Summary: Simply stated, the case for dividend stocks goes like this:
• Dividends are always positive.
• The best dividend-paying companies raise their dividends regularly, usually at a pace that exceeds inflation. Their growth is not curtailed by the dividend payouts.
• Dividends are not just for current income. They can be re-invested to accelerate the wealth-building process. Over time, a very high yield on cost can be achieved.
• Dividend stocks offer the potential for price appreciation in addition to the dividends they pay.
The Case Against Dividends: The anti-dividend articles, when combined, made the following case against dividends:
1. Retained earnings produce growth. Money sent out as dividends cannot contribute to growth.
2. Retained earnings, if not re-invested for growth, are better spent in share repurchases than in dividends.
3. Share repurchases and reinvestments in the business should fuel future price appreciation. Dividends do not. In fact, dividends reduce price appreciation.
4. Dividends reduce the value of the underlying shares by the amount of the dividend.
5. Studies do not find that dividend stocks “do better” than non-dividend-paying stocks.
6. It is more tax efficient to generate income from selling shares than from dividends.
7. Dividends’ appeal lies largely with uneducated shareholders. Companies use dividends to bribe shareholders and to exploit shareholder ignorance.
8. Would you want Warren Buffett to distribute dividends rather than keep doing what he’s been doing for decades (Berkshire Hathaway does not issue dividends)?
The Case for Dividends: Here, I am not trying to show that dividend stocks are always the best investment. But I am trying to show that dividend stocks can be the basis of a very intelligent and successful investment strategy. Dividend stocks are not just for retirees or clueless investors.
The Dual Nature of Dividend Stocks: Many investors think of stocks as assets that you trade with a focus on price: Buy low, sell high. If you mention income production, they think of bonds. But dividend-paying stocks are instruments with the power both to produce income and to rise in price. A good dividend stock is an equity security like all others, but with unique income characteristics.
What I call the Sensible Dividend Investor is not stupid or ignorant. But he or she often comes to see stocks differently from growth investors. Stocks become like cash machines that generate streams of income. Dividend investors do not lose all interest in the price of their shares, but price doesn’t matter as much. If prices fall, the dividends keep coming. Price declines often present attractive buying opportunities for those who are still in the wealth-accumulating stage of their lives.
The idea that dividends are the principal reason for owning a stock is not a new concept. In 1934, Benjamin Graham and David Dodd wrote in their classic Security Analysis, "The prime purpose of a business corporation is to pay dividends to its owners [emphasis added].” This statement is more than a quaint reflection of its time. It is a fundamental view of what owning shares in a company is all about, as valid today as 75 years ago.
Stock Prices Tell Only Half the Story: The total return from stocks is comprised of two elements: price appreciation and dividends. Studies show that dividends have accounted for half or more of the total return of the stock market over very long terms. Despite this, there is no widely publicized “dividend index” that gets the coverage given every day ro the Dow, S&P 500, and NASDAQ indexes, even though those reflect price changes only.
As to price appreciation: A company creates value by generating profits. It ingests investors’ capital and/or borrowed money to get started, and then it utilizes the skills of its people, research, development, manufacturing, marketing, and other functions to bring in more money than it spends. The net pileup of profits and assets, and the company’s ability to utilize those to bring in ever-larger earnings, increase the enterprise’s value over time.
In turn, the company’s stock price goes up if the market recognizes the increased value of the company. Historically, through a wisdom-of-crowds “price discovery” process, investors have tended to recognize and pay for increased earnings capabilities. They do this by placing an appropriate multiple on a company’s earnings per share. Over long periods of time, the multiple has averaged out around 15-16. That is, if a company makes $1 per share profit, its price will hang around $15 or $16. Sometimes, prices rise or fall because the market places a higher or lower multiple on the shares. The multiple thus reflects investor sentiment toward the stock, or toward the entire stock market.
The Dividend Half of the Story: First of all, note the obvious: Dividends are always positive—there is no such thing as a negative dividend. As to the long-term record of dividend stocks, I will focus on just two studies to save space.
• Wharton Professor Jeremy Siegel’s research attributes 97% of the stock market’s total return from 1871 to 2003 to re-invested dividends, and he also states that from 1926 to 2004, reinvestment of dividends accounted for 46% of all stock market return after inflation.
• In a February, 2009 article, “Follow the Juicy Dividends,” BusinessWeek cited Ned Davis research showing that stocks with at least five years of dividend growth outperformed the S&P 500 every year from 1972 to 2008. The study showed these annual total returns:
o Dividend Cutters or Eliminators: 0.5%
o Non-Dividend Payers: 0.7%
o S&P 500: 6.2%
o Dividend Payers with No Change in Dividends: 6.2%
o Dividend Growers and Initiators: 8.7%
The Share-Buyback Red Herring: One of the most-cited reasons against dividends is that shareholders are better off if the company uses that money to buy back shares of itself. Share repurchase programs are not regular programs. They are not predictable as to size or frequency. Some share repurchases are not completed after their announcement. In hard times, most companies will suspend a share buyback program before they touch the dividend.
Often companies pay top dollar for their shares. They don’t “buy low.” Figures from S&P show that few companies repurchased their shares in 2002, the bottom of the post-internet-bubble bear market. But when stock prices were increasing from 2003 to 2007, buybacks became rampant, peaking in Q3 2007, simultaneously with the market’s peak. Then in 2008-2009, when the next bear market hit, buybacks slowed dramatically. This phenomenon appears in every market cycle. USA Today ran a recent article in which it reported that S&P analysts studied stock repurchases from Jan. 1, 2006, through June 2007. They found that a third of all companies took losses from their purchases; three-quarters of the companies that bought back shares lagged behind the S&P 500 for the period; and the most aggressive buyers of their own stock were some of the worst performers.
The Taxation Issue: You must pay taxes on dividends. However, the Federal dividend tax rate of 15 percent makes it one of the least-taxed forms of income available. (Note: The 15 percent tax rate on dividends is due to expire at the end of 2010. Note also that dividends from REITs and certain other special corporate forms are taxed at your marginal tax rate, because their profits are not taxed at the corporate level.) Of course, if you hold your dividend stocks in a tax-deferred account, the normal tax benefits of such accounts apply to the dividends.
It is true that share repurchases are not taxed. But if you want to get the money from share price growth, you must sell some of the shares to get it. Your gain will be taxed at either the long-term or short-term capital gains rate. The Federal long-term rate is 15 percent, the same as with dividends.
Sometimes, investors become too focused on tax considerations. The primary appeal of dividends has never been based on a tax break; that is of recent origin anyway. The chief appeal of dividends is the opportunity to receive cash returns from stocks that are always positive, keep increasing, and are independent of price fluctuations.
Characteristics of the Best Dividend Companies: The best dividend companies have a strong culture of increasing the dividend annually if at all possible. Many have been increasing their dividends for decades. The top dividend-paying companies tend to have strong balance sheets and to handle cash conservatively. Most of them have rock-solid business models and are veritable cash machines. The best dividend-paying companies generate enough cash to fund both growth and dividends.
Dividends cannot be faked, unlike earnings. Paying dividends takes cash out of the hands of management and forces management to handle the remaining cash more carefully. As noted in the November 24, 2008 edition of Fortune, “Companies that retain most or all of their earnings frequently squander those profits. CEOs waste those retained earnings on ‘empire building’ via overpriced acquisitions. Amazingly, companies that pay big dividends actually grow their earnings far faster than those that reinvest most or all of their profits. Paying dividends imposes discipline; it makes the top brass far more careful in deploying scarce cash.”
Dividend stocks tend to attract a different constituency from growth companies. Many shareholders prefer a steady return and a predictable, reliable dividend flow. Investors following a dividend-growth strategy are less likely to sell their shares in response to short-term difficulties. The dividend stream is generally independent of price changes in the stock itself. Shareholders are, in a sense, set free from constant concern about the stock’s price. Dividend investing is a strategy for the long haul. The major attraction is not to make money from price increases, although that is delightful. The major attraction is the dividend itself.
The Power of Rising Dividends: Well-chosen dividend stocks increase their dividends every year, and those can be re-invested to accelerate the process of building wealth. Even if not re-invested, rising dividends obviously deliver increasing income. In contrast to growth stocks, dividend stocks do not have to be traded to realize these benefits.
The best dividend stocks usually grow their dividends at a higher rate than inflation, unlike the fixed dividend payment from most bonds. If you own shares in a dividend-paying company that increases its dividends, your yield on cost (that is, the yield on your original investment) goes up. This happens even though the current yield stays the same. It’s simple math. No matter how the stock’s price changes over the coming years, your personal yield (= yield on cost) will always be based on what you paid originally.
Over time, your personal yield will surpass the 10%-11% long term total average return of the stock market itself, just from the dividends alone. This is the most powerful aspect of dividend stocks. The process can be accelerated, of course, by re-investing the dividends and letting them compound.
This contrasts sharply with bonds. Bonds are fixed income investments. We can easily see the ways that they are “fixed”: Their term is fixed; their “coupon,” or rate of return, is fixed; and their nominal worth at the end of the term is fixed. You get back what you originally paid—in dollars that have been eroded by inflation.
Take a look at this table of returns for a terrific dividend company, Automatic Data Processing (ADP):
Year 2005 2006 2007 2008 2009
Price Return +5% +9% +3% -9% +9%
Dividend $0.65 0.79 0.98 1.20 1.33
Div. Increase +22% +24% +22% +11%
Note how the price return varies each year, including going negative in 2008. Also note how the dividend just keeps marching up each year. ADP has been raising its dividend for 35 straight years now, yields about 3.5% to new purchasers (much more than that to investors who have owned it for years), and is one of only four US non-financial companies with an AAA credit rating. Another of the four AAA-rated companies is Johnson & Johnson (JNJ), also a top dividend stock.
Of course, there is risk to any company’s dividend. If a company suffers dramatic financial misfortune, and its profits fall or disappear, so can its dividends. Financial calamity will trump any company’s desire and ability to keep sending out dividends. Dividends are not guaranteed. But for well-selected dividend payers, that risk is usually small.
What About Buffett? Do I want Berkshire Hathaway to pay dividends? Personally, I could not care less. I believe that every company has an optimum level of dividend payout that the company discovers over time, as it matures. For new companies, the optimum rate is almost always zero. They need all the cash they can get to grow from corporate infancy through adolescence and into adulthood. For some mature companies, this level is still zero, because of its business model. Berkshire Hathaway certainly has enough cash to pay a dividend, and who knows, they may choose to do so some day, just as Microsoft did a few years ago. But Buffett does OK with a zero dividend, and that’s fine with me.
Summary: Simply stated, the case for dividend stocks goes like this:
• Dividends are always positive.
• The best dividend-paying companies raise their dividends regularly, usually at a pace that exceeds inflation. Their growth is not curtailed by the dividend payouts.
• Dividends are not just for current income. They can be re-invested to accelerate the wealth-building process. Over time, a very high yield on cost can be achieved.
• Dividend stocks offer the potential for price appreciation in addition to the dividends they pay.
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