Price Dividend Ratio: Lessons From History

In Why The Price Dividend Ratio Is Better Than PE Ratio I argued that the lesser ratio based on dividends offers more insight. Here’s a follow up with an interactive long term chart.

It contains a massive amount of information so it can take a while to load… be patient, it is worth it. Not only does it show the historic ratio, it is interactive so you can zoom in on a shorter time frame by using the slider at the bottom:

The data is from 1871 to June 2008. To bring it up to date, the most recent data for the S&P 500 Index (SPX) gives a P/D ratio of just under 32. A year ago it was at 54. The last time we saw a price dividend ratio of 32 was in 1991. To put the current 3.13% dividend yield into perspective, in June 1932 stocks were yielding on average 14% and in July 1982, stocks yielded 6%.

Right now the Dow Jones price dividend ratio is 25.7 which is very close to the long term average. But the ratio can over shoot on the downside. By the way, I’m still looking for similar historical data for the Dow Jones, so if you have a lead, let me know.

And keep in mind that both the numerator and denominator are constantly changing, so this is a fluid number. Although we’ve seen prices fall dramatically these past few weeks, dividends can also fall. So the good news is that this ratio has fallen a lot but the bad news is that it can continue to fall as dividends are cut or reduced.

On the plus side, an important variable that can act as an emergency break on this ratio is the interest rate. If the Fed takes rates down to 1% or less, which some believe is a matter of when not if, then dividends will be much more attractive, relative to the alternatives in the bond market.

Already if you look around you’ll find quite a few high yielding household names like Pfizer (PFE) which is now yielding 7.7%. Looking back almost 30 years (I got tired of looking back more) Pfizer has never skipped or lowered a dividend payment but has consistently raised it.

Unless Bernanke takes interest rates down to zero, what we could be facing is a return of this ratio to the “normal” range it has occupied for most of its history. That is somewhere between 12 and 35. Under this scenario, the stock market would flop around for decades as it waited for dividend growth to catch up to it. We’ve seen this sort of market before. From 1966 to 1983 the Dow Jones was a snooze fest. Except for a few harrowing dips, it went sideways and grinded down even the most optimistic bull.

To avoid such a stark reality, I say the Fed should re-inflate like it was 1999 -

Disclosure: Author is massively long seaweed CDOs.

Comments

[Vox Rationalis:]

You should include tax policy in this analysis. For example, when capital gains is taxed at a lower rate than dividend income, there's an incentive for lowering dividend payments in favor of increased shareholder equity.

2008 Oct 28 12:02 PM

[BloggingBanks:]

Of course one of the reasons why the P/D was so high ( or the yields were so low) is because of the tech bubble in the 1990's early 2000s which caused a lot of non dividend paying stocks to be added to S&P 500

2008 Oct 28 12:47 PM

[Big Al45:]

Think the FED IS re-inflating like its 1999. But it doesn't seem to working.

Waxman needs to hold hearings on the seaweed bubble, ASAP.

Maybe Goldman Suchs' recent price decline can be traced to bad bets on seaweed CDOs. If so, TARP will be buying them.

2008 Oct 28 01:06 PM

[Kofi Bofah:]

Also, companies have taken to share buybacks, rather than allocating the capital towards increasing dividends. Share buybacks came into vogue as a gimmick to prop up earnings per share. In depth research often reveals the fallacy of the buyback.

1: The corporation is buying back stock at inflated prices.
2: Share buybacks often are a means to erase newly issued shares that have arrived courtesy of executive compensation.

I do think that investors should begin to execute investment decisions based upon income, rather than fairy tale capital gains.

2008 Oct 28 02:25 PM

[Boubou:]

I agree with Bofa. Basing a strategy solely on anticipation of capital gains works only if your time frames happen to span the right epoch.
A worker becoming a senior doesn't have that luxury.
And we have to trust that when the board retains our money instead of giving it to the owners, they do something useful and conservative, which adds to value.
And we have to trust that circumstances beyond the board's control don't overwhelm anything useful they may have attempted.
I prefer to take the dividend and decide what to do with it.

2008 Oct 29 10:36 AM