The Big Picture for the Week of January 1, 2012

After listening to the umpteenth segment on CNBC where both guests extolled the virtues of some version of dividend stocks, dividend growers or high yielders or the like, it has become clear that we have a very popular theme here. Over the last couple of years I’ve had some posts where I have tried to isolate the importance of dividends to a portfolio but tried to warn of the risk of a cultish devotion to them hence the term dividend zealot.

Also during the week I read a post at Seeking Alpha with a cautious tone on a dividend stock bubble and all the usual suspects chimed in about why dividend stocks can’t be a bubble.

For people not cultishly devoted (read all the comments on dividend articles at SA and tell me there isn’t a cultish tone) but still very interested in the topic I thought of a different way to articulate my thoughts on this subject which hopefully is useful. In listening to the aforementioned CNBC segments and the articles that have popped up people seem to think of dividend stocks as an asset class which I don’t think is the right way to look at it. People also think of dividends in terms of various strategies like dividend growth and so on and the strategy idea is a correct way to look at it but I don’t think it is the only way.

I think of dividends, more precisely yield, as an attribute to be managed in the portfolio. In the trade we executed during the week we added a name that has a pretty easy time paying 6%. I also mentioned that I expect to add a couple of other stocks with similar attributes (higher yield and low volatility) with an idea toward increasing the yield of the portfolio.

Part of my thesis for the decade is equity returns for the US market that are below “normal.” The last two years averaged out don’t refute the idea. Dividends over extremely long periods of time account for about half of equities’ total return and if I am right about the new decade then dividends might account for more than half. While I believe this to be a very plausible scenario it also appears that from the bottom up yields on many stocks are now quite a bit higher than they were in the 1990s or 2000s. It is much easier to find stocks yielding 3% than it was ten years ago.

In years past I wrote many times about targeting a 3% equity yield against the SPX’s 2% yield but now it might be possible to get a 4% yield against the SPX’s 2% for the next few years or longer. Please note that the context here is a portfolio diversified to include all SPX sectors along with foreign exposure and taking in a full range of attributes into the portfolio.

The reason SPX still yields only 2% is because the financial sector is still a large component and many of the biggest banks pay little or no dividend as ongoing fallout from the crisis–at least this is my opinion as to why SPX only yields 2%.

If my idea of a diversified portfolio (not that you should care about my idea of a diversified portfolio, but this is the process I am working through) can yield 4% (I’ve not yet come to that conclusion) and if it turns out that domestic equities only average 3-4% per year then that yield does a tremendous amount of heavy lifting for the portfolio. From there a couple of correct country decisions and figuring out one thing to avoid (hint:US and European banks) and there is a good chance of having a “normal” return in a below normal world.

And for anyone doubting their ability to correctly select a couple of countries and correctly avoid something; they can still have that yield to fall back on.

The picture is from the Arizona Sun Dogs hockey game last night. The Sun Dogs are Prescott’s minor league hockey team.

Happy New Year!

15 Comments

  1. Happy New Year Roger. The best to you and your family. Keep up the great posts.

    Cynthia

    Reply
  2. Thank you Cynthia, Happy New Year to you too!

    Reply
  3. As usual, what to do depends. In a taxable account, more dividends might not be a good idea especially if dividends are taxed at a higher rate in the future. Since that possibility cannot be ruled out, total return investing might be a superior approach.

    I have posted this link to this Vaguard paper before, “Spending From a Portfolio: Implications
    of a Total-Return Approach Versus
    an Income Approach for Taxable Investors”

    http://bit.ly/azqnOk

    Roger, I am glad to see that you now acknowledge the importance of dividends to stock returns. I remember some time back when you said that the SP500 price included dividends as is written in some of your older posts. Was it the Zweig article in the WSJ earlier this year that brought you around?

    Reply
  4. I’m sorry I don’t follow your comment. I’ve been talking about generally targeting a slightly higher div yield than the SPX since the start of the site.

    There are years like 2003 or 2009 where dividends don’t mean much in hindsight but whatever you are referring to was either worded poorly by me or you misread.

    Reply
  5. Thanks for today’s post, Roger. As a retiree, I’m probably more interested than most in a balanced discussion of the topic.

    Happy New Year. Go crazy and have a soda tonight. I think the DZs are leaning a bit more toward PEP right now 🙂

    Reply
  6. Nevermind, it is not worth rehashing.

    Thanks for all your efforts through this blog.

    7:38

    Reply
  7. nice soda heckle, we don’t have an PEP or KO in the house though!

    Reply
  8. Dividends over the years have helped put two kids through college and have helped pay for vacations from coast to coast. And helped pay for home maintenance, etc. And I trust dividends will provide similar assistance in retirement.

    Over the decades I’ve found that stocks with rising dividends generally also produce capital gains. Generally, not always.

    I don’t wish to be considered a dividend zealot but dividend-related investing is part of our overall approach.

    Beyond that: Hey people, it’s New Year’s Eve. Pop open something a bit better than KO or PEP!

    I’d suggest Gruet, a pleasant sparking wine, brut or rose, with a very reasonable price. It is made, wait for it, in Albuquerque! By a French family who arrived there in the 1980s.

    Gruet is something that will provide you with a fine dividend indeed.

    Happy New Year to all.

    BillM

    Reply
  9. if anything i am more of a dark beer guy; beer so dark you gave to chew it

    happy new year BillM

    Reply
  10. If you’re not drinking Everclear out of a plastic bottle inside a paper bag tonight, you’re not going to have much to look forward to in 2012!
    Happy New Year…

    Reply
  11. I think at least one reason dividends have become more fashionable is that many baby boomers, including myself, are approaching the stage of life where we intend to harvest a little (or maybe more than a little) from those portfolios we have been investing in all these past years, and don’t necessarily want to sell anything.

    Reply
  12. Given the year you’ve had investing, I’d suggest worrying less about what soda people drink and more about improving your performance.

    Reply
  13. Steady growth of dividends — not the same thing as high dividends of course — was one of the first equity investing strategies I learned. Back in the 80’s when transaction costs were steep (slippage was huge in those days) I implemented the strategy in dividend reinvestment plans (DRiP) from companies that not only managed their own plans but offered shares direct to investors (don’t think there any that do that now but could be wrong).

    Still own several of those DRiP’s — JNJ, JCI, STR — and will probably just donate the shares to charity since the cost of cashing them in would be fairly prohibitive even at the current low cap gains rate. All the plans are serviced by third parties these days (Wells Fargo is a major player in this space) but it’s still not a bad way to go for the individual investor IMO.

    NB: I’ve been thinking about the increase in correlation between markets and across asset classes for some time and its implications for portfolio diversification and think this article at http://tinyurl.com/7ast8y5 lays out some important markers. One of those is that the lower cost and (relative) democratization of financial information means a lot more people have the same data to work with and that naturally translates into a higher correlation.

    But the flip side of that is where you gain advantage. If you are a big player there are three ways: You know what others don’t, you are faster (hi-freq algos) or you set the rules/capture regulators.

    If you are small you also have three: agility, position size flexibility and patience.

    A productive and blessed new year to all and sundry (and for Anon 3:52PM, a lighter touch).

    Reply

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The Big Picture for the Week of January 1, 2012

After listening to the umpteenth segment on CNBC where both guests extolled the virtues of some version of dividend stocks, dividend growers or high yielders or the like, it has become clear that we have a very popular theme here. Over the last couple of years I’ve had some posts where I have tried to isolate the importance of dividends to a portfolio but tried to warn of the risk of a cultish devotion to them hence the term dividend zealot.

Also during the week I read a post at Seeking Alpha with a cautious tone on a dividend stock bubble and all the usual suspects chimed in about why dividend stocks can’t be a bubble.

For people not cultishly devoted (read all the comments on dividend articles at SA and tell me there isn’t a cultish tone) but still very interested in the topic I thought of a different way to articulate my thoughts on this subject which hopefully is useful. In listening to the aforementioned CNBC segments and the articles that have popped up people seem to think of dividend stocks as an asset class which I don’t think is the right way to look at it. People also think of dividends in terms of various strategies like dividend growth and so on and the strategy idea is a correct way to look at it but I don’t think it is the only way.

I think of dividends, more precisely yield, as an attribute to be managed in the portfolio. In the trade we executed during the week we added a name that has a pretty easy time paying 6%. I also mentioned that I expect to add a couple of other stocks with similar attributes (higher yield and low volatility) with an idea toward increasing the yield of the portfolio.

Part of my thesis for the decade is equity returns for the US market that are below “normal.” The last two years averaged out don’t refute the idea. Dividends over extremely long periods of time account for about half of equities’ total return and if I am right about the new decade then dividends might account for more than half. While I believe this to be a very plausible scenario it also appears that from the bottom up yields on many stocks are now quite a bit higher than they were in the 1990s or 2000s. It is much easier to find stocks yielding 3% than it was ten years ago.

In years past I wrote many times about targeting a 3% equity yield against the SPX’s 2% yield but now it might be possible to get a 4% yield against the SPX’s 2% for the next few years or longer. Please note that the context here is a portfolio diversified to include all SPX sectors along with foreign exposure and taking in a full range of attributes into the portfolio.

The reason SPX still yields only 2% is because the financial sector is still a large component and many of the biggest banks pay little or no dividend as ongoing fallout from the crisis–at least this is my opinion as to why SPX only yields 2%.

If my idea of a diversified portfolio (not that you should care about my idea of a diversified portfolio, but this is the process I am working through) can yield 4% (I’ve not yet come to that conclusion) and if it turns out that domestic equities only average 3-4% per year then that yield does a tremendous amount of heavy lifting for the portfolio. From there a couple of correct country decisions and figuring out one thing to avoid (hint:US and European banks) and there is a good chance of having a “normal” return in a below normal world.

And for anyone doubting their ability to correctly select a couple of countries and correctly avoid something; they can still have that yield to fall back on.

The picture is from the Arizona Sun Dogs hockey game last night. The Sun Dogs are Prescott’s minor league hockey team.

Happy New Year!

Submit a Comment

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