Dividend Stocks in place of Bonds

[cute fuzzy bunny]

I think once again we're tied up in the mechanics and missing the point.

I believe Mathjak's original point was that dividends dont really matter because the stock price is adjusted to offset the dividend.

Which does happen so that open orders dont get screwed up when the stock 'drops'.

But actual market action does not bear out mathjaks assertion. Seems to me that most issues are immediately marked back up (or down) in line with buyers and sellers psychology and existing market action.

This is sort of like telling a nascar driver that going so far wears out the tires and uses a lot of gasoline. Technically correct but not particularly interesting or applicable.

 

[mathjak107]

i think the point to the whole thing is you cant predict whether the market will let the stock re-cover from the dividend or not . looking at the 10 highest dividend paying dow stocks ,if you bought them 2 or 3 years ago depending whether you bought all or some your principal could be in a real pickle. so using dividend paying stocks in place of bonds is a bad idea in my opinion

 

[cute fuzzy bunny]

I cant predict what i'm having for breakfast today (okay, I can...homemade chorizo, eggs on green chili corn tortillas...). What I can predict is that using a worst case example, like the doggiest dogs of the dow, isnt going to be the plan i'd implement either...

Funny but we just had a big discussion where a fair number of people felt that the near-intermediate markets would be terrible for bonds. Seems that the arguments for those conditions would favor a big basket of dividend paying value stocks.

 

[Gone4Good]

But actual market action does not bear out mathjaks assertion. Seems to me that most issues are immediately marked back up (or down) in line with buyers and sellers psychology and existing market action.

It seems that both parties are standing on a patch of ground which is technically correct and neither will admit the truth in the other's point. So I'll say it . . . both mathjak and CFB/Nords have factually correct points.

1) The open orders are adjusted downward when stocks go ex-dividend. (Score for mathjak)

2) However, open orders carrying over from the prior day do not constitute the whole market. New orders coming in the morning the stock trades ex, are added to the book and settled at the open resulting in an opening price that can be wildly different from the closing price - the dividend. (Score for CFB/Nords)

What this has to do with buying dividend stocks, or stocks in general, I haven't a clue. The relevant fact, stated earlier (by me), is that it doesn't matter whether a firm pays dividends or does not . . . total returns (which is what matters) will be the same regardless.

 

[cute fuzzy bunny]

As I said, Mathjak's point was that dividends didnt matter because the stock price was adjusted.

Which is irrelevant because the price immediately moves, without necessarily any correlation with the exchanges 'adjustment'.

I'd dispute your claim of total returns being the same...in the short to intermediate term, market prices may or may not have a bearing on the companies earnings and financials. Long term, if identical companies XYZ and ABC both earn the same and have the same financials, but XYZ pays a dividend while ABC burns a billion dollars in R&D that bears no fruit...I think long term you'd have a better valued investment in XYZ.

 

[mathjak107]

hmmmm what would microsoft or apple think of that

 

[cute fuzzy bunny]

Probably a lot differently than Altria or General Electric?

 

[Gone4Good]

Long term, if identical companies XYZ and ABC both earn the same and have the same financials, but XYZ pays a dividend while ABC burns a billion dollars in R&D that bears no fruit...I think long term you'd have a better valued investment in XYZ.

Well gee, if you assume that company ABC wastes money and XYZ doesn't then sure. We could just as easily assume that ABC reinvests in projects that earn returns greater than its cost of capital . . . in which case ABC would provide better long run returns then XYZ.

However, if we start with the fair assumption that besides the dividend, all else is equal, then XYZ and ABC will have the same long-run returns.

 

[clifp]

i think the point to the whole thing is you cant predict whether the market will let the stock re-cover from the dividend or not . looking at the 10 highest dividend paying dow stocks ,if you bought them 2 or 3 years ago depending whether you bought all or some your principal could be in a real pickle. so using dividend paying stocks in place of bonds is a bad idea in my opinion

To some extent who cares about the principal, what matters is the income.
First holding bonds doesn't protect from losing principal. If you hold bond funds (prudent I think for holding corporate bonds, and even some Government securities like GNMAs), if interest rates increase you have a paper loss of principal (one which potentially permanent if interest rate stay high for a long period of time). The alternative is to hold individual bonds, which again are subject to a temporary loss of principal. If you hold individual government bonds while your principal and interest are safe your returns are quite low,on the other hand individual corporate bonds, suffer almost the same fate as stockholder if the company goes bankrupt. In fact bond holder often have even worse company risks. For example in a situation like we see with Sallie Mae, a good thing for stockholders like a takeover, is a bad thing for bond holders.


Lets take a look at at dividend stocks. Below I've listed the yearly dividend payout history of all of the highest yielding stocks in the DJIA. Depending on when you bought in the last 4 1/2 years these stocks would have pretty much covered the dogs of the Dow.

2003 2006

Alteria 2.44 3.32
Citigroup 1.99 3.52
AT&T 1.07 1.33
Caterpillar .70 1.20
Dupont 1.40 1.48
Exxon .92 1.28
GE .73 1.03
GM 2.00 1.00
Honeywell .75 .91
JP Morgan 1.36 1.36
Johnson Johnson .80 1.46
Merck 1.42 1.52
MMM 1.24 1.84
Pfizer .52 .96
Verizon 1.38 1.56

Eastman Kodak* 1.80 .50

*2003 Dog dropped from Dow Jones Average

I think the importance thing to note is that except for Eastman Kodak and General Motor which cut dividends, and JP Morgan which maintained dividends, all other company on the list increased dividends, in most cases much faster than inflation. The result is that unlike the buyers of 10 year T-Bill the retirees income would have increased, even after suffering a dividend cut from GM and Kodak.

Morever in Dec 2002 the Dogs of the dow were yielding 4.2% vs a 10 Year T-Bill of 4.0%. Even in 2006 the dogs were yielding 3.6% vs a 4.6% 10 year T-Bill. So the dividend investor was starting off with more income than the bond investor, and ended this year with more income. This year you'd take a 1% hit but you'd have more favorable tax treatment. The nice thing is all of the numbers are pretty close to a 4% SWR and as long as dividend growth increases near the inflation rate you don't have to worry about the current stock prices of your portfolio. Although obviously, with more than 1/2 of the DOW on the list and the DJIA at record levels there has been a good capital appreciation also.

I still think you should have some money in bonds/MM/CDs, but I do think dividend stocks can be used as a substitute for much of the bond allocation portfolio, allowing you to keep your cash/bond allocation to 10-25% level.

 

[mathjak107]

tell you what if principal dosent matter give me 10,000 bucks and ill gladley pay you 10% for 5 years but i keep the principal. of course it matters.


the average swing for a stock price is between 35-40% a year. i highly doubt any high quality treasury or corporate bond will swing like that. tell the people who retired in 2000 principal dosnt matter as 40% of their nest egg evaporated in the s&p alone.

and these bonds will pay off in full at maturity if held .. they behave in a way like cd's. you are no more or less exposed to interest rate fluctuations than you are with a cd.you get exactly what you bargained for. if you stay with treasuries there is no risk to speak of. if you planned properly you still get the income you need and your principal remains to fight another day.

if you planned properly the numbers work based on the anticipated cash flow from the interest levels you are going to get .

i have a place for my dividend paying stocks but it isnt in my income bucket, its in my stock bucket WHERE THERE IS NO CHANCE ILL EVER HAVE TO LIQUIDATE THEM IN A DOWN MARKET in case dividends are cut and i need more income..


reminds me of the junk bond thinking of the 80's . oh the income stream was fabulous but your principal was gone .

 

[mathjak107]

did you notice how many of those dow stocks are worth less today than in 2003, just look at merk it was 60 bucks in 2003 and in the 30's today. verizon is lower too. in fact i bet most of them are less today but im not going to look them all up.

if you think you got a good total return from it your deluding yourself.
dont confuse an increase in yield with an increase in dividends. in some cases it comes from a falling stock price

 

[clifp]

did you notice how many of those dow stocks are worth less today than in 2003, just look at merk it was 60 bucks in 2003 and in the 30's today. verizon is lower too. in fact i bet most of them are less today but im not going to look them all up.

if you think you got a good total return from it your deluding yourself.
dont confuse an increase in yield with an increase in dividends. in some cases it comes from a falling stock price

DJIA 5/16/2003 8713
DJIA 5/16/2007 13476

Percent increase 54.7% now the Dow is an old average and not as accurate as something like the S&P or Wilshire. On the other I am not including dividends which push the total return up another ~10%.

Where did you get the $30 figure? Merck closed at $52.46 today in May 2003 it was $52.58 about as close to flat as possible. You did get about $5.90 in dividends over the 4 years.

Verizon was 36.46 in May of 2003, it closed at 42.14 today a 15.6% gain. You also collected about $6.30 in dividends or another 17%
Over course of the last 4 years several Dow Dogs, MO, T, CAT, HON, XOM have annual total returns in excess of 12% all while paying meaningful dividends.
All data from Morningstar.

was quite careful not to talk about yield but rather should specific dividend increase of household name companies. I am honestly not even particularly big fan of the Dogs of the Dow... Although I think it is pretty safe way of getting raising income.

the average swing for a stock price is between 35-40% a year. i highly doubt any high quality treasury or corporate bond will swing like that. tell the people who retired in 2000 principal dosnt matter as 40% of their nest egg evaporated in the s&p alone.

Yup, I am sure the Enron bond holders felt that way also, probably even those nice little old ladies who bought GM, Ford, or Chrysler long bond 10-20 years. Heck, I recently bought some Sallie Mae inflation "bonds" and I am not happy about the prospect of them being taking private.
Now with respect to Treasury I agree with you nice and safe. The problem of course is getting a real return above 3% much less 4% need for a SWR.
Still, Seigel in his book Stock for the long Run has some scary data about the fate of bond holders during certain period of the US and down right terrifying stories for holder of foreign country bonds. Holders of dividend stocks did ok in German in the 20s while bond holders were wiped. Getting your principal back ten years from now won't seem like such a great deal if Gas and Milk both cost $10/gallon.

I

 

[cute fuzzy bunny]

Well gee, if you assume that company ABC wastes money and XYZ doesn't then sure. We could just as easily assume that ABC reinvests in projects that earn returns greater than its cost of capital . . . in which case ABC would provide better long run returns then XYZ.

However, if we start with the fair assumption that besides the dividend, all else is equal, then XYZ and ABC will have the same long-run returns.

I thought it was plenty fair. Lots of companies when flush with cash find stupid things to spend it on. If its paid out in a dividend, theres no wad of cash to tempt silliness.

Clif and I could tell you how fabulously effective our old company's forays into surfboard mounted computers and televisions were... methinks they needed to increase the dividend a few years back...

 

[saluki9]

Clif and I could tell you how fabulously effective our old company's forays into surfboard mounted computers and televisions were... methinks they needed to increase the dividend a few years back...

Heck, we could start a whole thread of things they shouldn't have dumped any money into. Where to start?

 

[Nords]

Clif and I could tell you how fabulously effective our old company's forays into surfboard mounted computers

... And I'd like to thank you both for killing that project!

 

[terminator]

did you notice how many of those dow stocks are worth less today than in 2003, just look at merk it was 60 bucks in 2003 and in the 30's today. verizon is lower too. in fact i bet most of them are less today but im not going to look them all up.

Following up on clifp's post about VZ and MRK, the answer to 'how many of the 30 Dow stocks are lower today than in May of 2003 (when counting the dividends paid)' is TWO out of thirty. The one with the worst loss over that time period shows a total loss of about 5% over four years and the second worst had a total loss of less than 1%.

 

[mathjak107]

ooops your correct about merk hit the wrong date but its still about the same as 2003, in the 50's .. overall the point still remains the same, i would never want to be in the position as a retiree to be forced to liquidate stocks in a down market in a pinch or emergency or even to rebalance . i choose never to use any form of stock as a proxy for my bonds and cash.

 

[cute fuzzy bunny]

I agree...thats why I take and spend the dividends and have no need or plan to liquidate the equities at all...in an up or down market.

 

[clifp]

I agree...thats why I take and spend the dividends and have no need or plan to liquidate the equities at all...in an up or down market.

Yup same here. At the risk of being a called a dirty market timer, I tend to buy more bonds when the income from them is substanially higher than "good" dividend stocks.

 

[mathjak107]

Following up on clifp's post about VZ and MRK, the answer to 'how many of the 30 Dow stocks are lower today than in May of 2003 (when counting the dividends paid)' is TWO out of thirty. The one with the worst loss over that time period shows a total loss of about 5% over four years and the second worst had a total loss of less than 1%.

key word here is "when counting dividends paid" that was another point i was trying to make. that the dividends can be no free lunch as many like to think of it as bank or bond interest. in order to pull some of them out of the negative you must add that money back into the equation. in fact i dont think the s&p has broken a new high since 2000 without figuring dividends back into the figures

im not quite sure where im going with this ha ha but i think the point is that had many of them re-covered from all the money paid out making them whole again then you wouldnt have to count the free lunch money to do so as the payments would have been non events as some like to think.

did i say that right?

 

[cute fuzzy bunny]

im not quite sure where im going with this

did i say that right?

Yeah, I think you did.

I suppose that looking at markets and seeing that the bulk of the historic returns were from dividends isnt a swaying factor? Or bernsteins whole analysis on value vs growth stocks is just poofery?

 

[terminator]

key word here is "when counting dividends paid" that was another point i was trying to make.

There were only a couple more that needed the dividends added back in to be ahead since 2003. The other 25 or 26 were higher on share price alone.

that the dividends can be no free lunch as many like to think of it as bank or bond interest.

Short term I agree with you. Dividends paid reduce shareholders' equity so there is no free lunch.

But long term, it's the difference between: (a) a 100 year loan with no payments and accruing interest with a huge balloon at the end, and (b) a fifteen year mortgage with monthly payments being made. At the end of the day, if the interest rate is the same and the monies collected are re-invested at the same return, everything is equal. But I think we all realize that (b) is a lot better than (a) if you are the lender.

If you trust the company, then retention of dividends is better from a tax perspective. But management's interests clearly aren't 100% aligned with shareholder interests (or else we wouldn't have some of these ridiculous eight-figure salaries and some of the empire-building that occurs). And when our interests aren't 100% aligned, I don't trust management 100% so I'd rather have some of the profits in my hand.

Companies with no dividends and no plans to ever pay a dividend rely 100% on Mr. Market to value a partial liquidation of their investment. Companies paying dividends are not reliant on a potentially irrational Mr. Market to value a partial liquidation for them as they can choose to just take the dividends if prices are low or to sell some shares in prices are high.

 

[terminator]

I suppose that looking at markets and seeing that the bulk of the historic returns were from dividends isnt a swaying factor?

Historically, the payout ratios were quite a bit higher. I've read that 50-75 years ago the majority of earnings were being paid out as dividends (I think the "average" payout ratio was 65% or so). So, back then the payout ratio defined/necessitated that the majority of the return was in the dividend by the nature of the way things were being done.

 

[cute fuzzy bunny]

Which leads us back to the crux (and thanks for the segue).

If holding back the dividends results in higher share prices, then we should be seeing a substantially higher curve on share prices now that dividend payouts are smaller.

Yet, excepting that nutty 1995-2000 period, returns for the market indexes dont appear to be changing in correlation to the overall reduction in dividend payouts. There has been a little pickup since the 70's, but its a far more muted change than you'd expect if you believed that a dollar not paid out in dividends equaled a dollar increase in stock price.

 

[2B]

Companies with no dividends and no plans to ever pay a dividend rely 100% on Mr. Market to value a partial liquidation of their investment. Companies paying dividends are not reliant on a potentially irrational Mr. Market to value a partial liquidation for them as they can choose to just take the dividends if prices are low or to sell some shares in prices are high.

I miss the days when a "normal" stock had a 4+% dividend. Now companies and the financial "sophisticates" seem to think that paying a dividend is just like throwing money away. The hot item now is share buybacks. This does have the effect of increasing earnings per share and should cause the stock price to rise. The capital gains are supposedly tax deferred until the sale. Unfortunately, the price appreciation is not as certain and the buyback itself has the possibility of double dealing. Another nasty element is that a lot of buyback announcements are made but never executed. No dividend. No buyback. Where did the extra cash go?

My outlook on retirement planning would be significantly different if I could "assume" a 4% portfolio cash dividend.