Dividend Stocks in place of Bonds

[terminator]

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.

I like a mix of dividends, buybacks and re-investment. There are a lot of good companies now doing all three.

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?

I think that part of the problem is that the cash is held as cash or buys an underperforming asset. If the company puts $5 of earnings in the bank and lets it sit there, there market practically ignores it. Anyway, I analyze a lot of individual stocks and it seems that the cash gets ignored a lot since it isn't generating revenue (per se). I'm surprised how often companies in the same industry with identical earnings are valued similarly even when one has little debt and a lot of cash and the other is a borrower with no cash reserves.

On a related note, I'm almost surprised there isn't a contrary fund that shorts the stocks of companies that announce buyback plans but never buyback shares. They do it for the kick of publicity, but usually it's an indicator of a cash poor company. I'm also always surprised at some of the lousy companies that borrow money to buyback shares. Not saying it can't ever be worthwhile, but when you have to add to debt to buyback shares it's probably a bad idea.

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

I'm pretty conservative and diversified and I have a current stock dividend yield of about 2.5% and an income stream closer to 3% when you consider the cash/bonds. Not 4% but something close and it's pretty diversified and safe.

 

[Gone4Good]

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.

Hardly fair . . . and I also think you know better.

If the assumption is that most companies waste shareholder capital then it doesn't make much sense for anyone to invest in equities and is absolutely absurd to invest in an index. The whole point of owning equities is that companies reinvest in projects that produce suitable returns. Most do, some don't. But if you really assume most don't, then all dividend paying companies do is recycle your after tax dollars into a taxable cash flow stream while consuming your principal. Better off putting it in a bank with a higher yield and principal protection.

Besides, paying a dividend is no guarantee, or even a protection against, bad corporate investments. Most companies are not free cash flow positive, which means that they borrow to pay the dividend. Not sure how that enhances discipline.

 

[Gone4Good]

. . .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.

Huh?? Average recovery for unsecured bonds in bankruptcy is about 60 cents on the dollar. Average recovery for equity is just about 0.

Average 10-year default rate for investment grade corporates is something in the low single digit percentages. Average percentage of individual corporate equities that decline by 40% or more over a 10-year period . . . substantially higher.

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.

Sure, but absent a bankruptcy your Sallie Mae bond will deliver exactly what was promised if you hold to maturity.

Besides, I would no sooner invest in a handful of bonds then I would invest in a handful of equities.

 

[Gone4Good]

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.

That's simply not true. Seriously everyone. If people are going to make claims (like "real" inflation is 7%, or total returns were higher when companies paid out more of their earnings in dividends, for example) please at least check some facts to support your assertion.

From 1935 to 2006 the S&P has produced total return average annual returns of 10.9%, including reinvested dividends. Average dividend yield over that period was 4.1%

From 1980 to 2006 the S&P has produced total average annual returns of 13.1%, including reinvested dividends. Average dividend yield over that period was 2.79%.

Other 10-year periods chosen for their average dividend yield, but basically at random:

Avg. Total Return (incl div) Avg. Div Yield
1936-1945 8.2% 5.5%
1959-1968 9.8% 3.1%
1973-1982 6.5% 4.7%
1997-2006 8.3% 1.5%

Hell, one might conclude that higher dividend yields actually produce lower total returns (which actually makes sense if you believe companies generally earn greater than WACC returns on their investments).

 

[cute fuzzy bunny]

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.

Shoot its not often I have to quote myself because people missed it the first time.

Oh wait a minute...most of the time people start typing their replies after reading 3 words of my posts. Nevermind...

There are a lot of factors contributing to the pickup since the early 70's. So far I havent heard anyone claim that the reduction in dividend payouts was one of them.

And yes, I do think that flush with cash, companies often do incredibly stupid things with it, which often has no shareholder value.

 

[Nords]

From 1980 to 2006 the S&P has produced total average annual returns of 13.1%, including reinvested dividends. Average dividend yield over that period was 2.79%.

I think the problem is more complicated than a simple two or three factors, and here's one that hasn't been brought up yet. I've been re-reading Maggie Mahar's "Bull!", which includes an entire chapter on why company execs worked very hard to kill dividends and to boost share buybacks.

Options.

Back then options were "free money" that didn't count against profits. Now that options require some standard of cost accounting, they may be less favorable than restricted stock. What if an exec can collect dividends from that restricted stock instead of having to wait for the price to rise (or even having to leave the company)?

Dividends were also much more heavily taxed in the ending years of the 20th century. Favorable tax policy has been a strong driver in the "growth" of dividend funds since 2003.

As for execs and cash allocation, I think research has shown that they generally suck at it. What execs are best at is optimizing a process (usually by whittling away at the costs) and improving sales (especially with slightly different brands or global marketing). What execs truly suck at is figuring out what to do with the resulting fire hose of profits. If there were more people who knew what to do with a cash flow then there'd be a lot more insurance companies & Buffetts.

 

[cute fuzzy bunny]

Ding Ding Ding!!!

An interesting read...

http://www.pbs.org/wsw/opinion/geoff1219.html

 

[mathjak107]

interesting thing about the double taxation on the dividends. but it goes back to my origional statement. dividend stocks out perform because investors like them ,its a mental thing. not for sound economic reasons .


hmmmm isnt that how this thread got started?

 

[cute fuzzy bunny]

For almost every investment set and priced to market, that statement is true.

At least you get paid along the way with a dividend stock while people are being irrational .

 

[mathjak107]

yep just look at gold when its hot

 

[Gone4Good]

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.

Dude, you can quote yourself all you want and pretend it says something it doesn't . . . or you could simply say "I was wrong."

"A little pick-up since the 70's" is actually 200 bp in average annual returns. Meanwhile dividend yields are more than 100bp lower.

 

[cute fuzzy bunny]

I was wrong?

Hmmm...seems like in looking at the data and seeing that (excepting the late 90's irrational exuberance) that returns were trending downward with dividend cuts.

Not to mention that most pundits from Bernstein to Bogle are predicting lower future returns as a direct function of reduced dividends.

And theres that pesky article I linked to that directly suggests that executives tend to just not do good things with money left in their hands.

All of which seems to point to both of your thesis' being incorrect.

But I guess if you say it a few more times it might become true.

 

[unclemick]

Heh heh heh he heh heh - anyone notice how many new mutual funds have come out(pick your time period) recently with the D word in them - as in Pssst - dividends!

It's Wall Street feeding the ducks.

NO! NO! NO! The Norwegian widow had nothing to do with it/will not speak to anyone without her lawyer present/reserves the right to take/drink the fifth if served.

It's all Clinton's fault - or maybe the tax cut on dividends.

heh heh heh - we have any Sun spot or eclipse cycles going on? :

 

[cute fuzzy bunny]

Lets see, now that I have a bit more time...

http://www.fpanet.org/journal/articles/2002_Issues/jfp0702-art8.cfm

Examination of models and papers put forth by Siegel, Fama and French, Schiller and others.

Bottom line conclusions:

"Fama, French and most other scholars agree with the following points: (1) market returns in the last half of the 20th century, especially returns in the 1980s and 1990s, were better than expected because market multiples rose unexpectedly; (2) a substantial decrease in the equity risk premium is largely responsible for the sharp rise in market multiples. As we shall see, a decrease in the equity risk premium has implications for future stock returns."
[...]
"The decrease in the payout ratio increases the dividends multiple to 23.8, but the equilibrium stock price and earnings multiple are not affected."
[...]
"Let us look at the implications of these examples. Fischer Black (1976) reviews dividend policy and concludes that theory provides no help in determining why firms pay dividends or in determining the market’s optimal dividend payout policy. Historically, the market’s dividend payout ratio has declined sharply and unexpectedly since the early 1980s. Both theory and history suggest that the market’s dividend payout ratio is unstable. An unstable payout ratio implies an unstable dividends multiple, which implies the dividends model is invalid."
[...]
"Fama and French (2001) predict that the future dividend growth rate will repeat a historic average; they do not project faster growth due to today’s low dividend payout ratio."

In other words, the primary driver of the earnings increase you've noted is an increase in market multiples, and not having anything to do with dividends. In fact, this range of scholars appears to find no correlation whatsoever between dividend payouts and stock prices.

Dude, you can quote yourself all you want and pretend it says something it doesn't . . . or you could simply say "I was wrong."

Will you be following your own advice at this juncture?

 

[clifp]

Huh?? Average recovery for unsecured bonds in bankruptcy is about 60 cents on the dollar. Average recovery for equity is just about 0.

Average 10-year default rate for investment grade corporates is something in the low single digit percentages. Average percentage of individual corporate equities that decline by 40% or more over a 10-year period . . . substantially higher.

Interesting data do you have a source? One thing that I wonder about when they quote default rates is are they really making a fair comparison. 6 years GM had an A credit rating well above junk.
If it goes bankrupt in the next few years is going to increase the default rate for investment grade corporates or because its been junk status for the last few years are its bonds not going to be considered "investment grade"?