The Wonderful World of Dividend Yields

You read about such things in books; you gaze at the historical charts; but rarely do you live through such events in real time. Such is the nature of extremes in economic and financial cycles.

Reviewing history with the safety and objectivity of distance, it's easy to pledge grand schemes for taking advantage of the great buying opportunities the next time they come around. But talk is cheap. Who among us would have the courage, the fortitude, the discipline, the temerity to buy stock in, say, 1932? Or 1974? Looking back, the timing was right, although that is obvious only with hindsight. Nonetheless, some mustered the discipline to buy in those and other dire moments. Yet such intrepid actions were -- and always will be -- the exception.

So it goes in times of crisis, which also describes the current predicament. It is the height of irony and frustration that the financial gods only extend great bargains when the broader financial and economic context looks darkest. Analyzing that recurring state of affairs is easy; acting on it is atypical, to say the least.

All of this comes to mind as we look at trailing dividend yields. The chart below graphically captures the drama in global equity markets of late, October's close in particular. The trend needs no explanation. The question is whether the latest data points are compelling? And if not, why not?

We've discussed dividend yields before, and so readers are encouraged to review the debate, including this post, and its predecessor here. No, trailing dividends aren't a magic solution for easy profits, largely because only the past is revealed with full clarity. As such, dividend yields have been known to mislead us at times--sometimes it's a trap. But not always. Trying to distinguish one from the other is what's known as risk analysis. And risk is always lurking, including these ever-popular worries:

• Are dividend cuts coming, thereby diminishing the allure of the trailing yields?
• Is inflation headed higher, which makes real dividend yields less attractive than they appear to be in nominal terms?
• Will capital losses overwhelm dividends going forward?

And on and on we go. There's always a reason to question an apparent gift. One might wonder why such worries are on everyone's lips in a bear market but tend to be missing in action in a roaring bull market, but we'll leave that for another day.

Meantime, it's clear that we should always be suspicious of any one market metric in the absence of broader financial and economic context. Perspective comes in handy -- always. But generally speaking, we like dividends, which is to say we enjoy receiving payments from our equity investments, and the more, the better.

Alas, we have no control over the absolute amount of dividends dispensed by our equity allocation. But we're not completely at the mercy of Mr. Market. We do, still, have executive authority over the timing and the amount of equity investments, and that ain't hay. It's a power that's fraught with risk, of course, but beggars can't be choosy.

If we think of dividend payouts as coming at a price -- a variable price through time -- it should come as no shock to learn that we're disposed to pay as little as possible for access to a stream of dividends. Presumably, no one on the planet disagrees with the concept overall. The details, in real time, are something else, and so explaining why it's so hard to take advantage of yield opportunities is infinitely more complicated.

Comments

[jepittman:]

In my experience 'reaching' for yield has been painful to say the least. Dividends can be reduced or eliminated. Witness many bank stocks during this decline. However companies in defensive industries with clean balance sheets and relatively low payout ratios who are in positions to grow their dividends have over the years been generally good investments. They can be boring but today I am most proud of my dull, consistent dividend paying / raising investments.

2008 Nov 10 12:30 PM

[Chris B:]

Agreed jepittman,

I fail to see the logic in chasing 6% yields that will probably be cut when stock prices are moving + - 10% daily.

More importantly, with corporate borrowing costs extraordinarily high, do you really want your companies sending out dividends with one hand and borrowing at 7-10% interest with the other? Are dividend-paying companies building reserves for contingencies such as the commercial paper markets locking up again or their customers being unable to finance their purchases? Perhaps we should de-stigmatize dividend cuts and encourage them whenever a company's cost of borrowing exceeds the amount an investor could earn in a bond fund at the time. Otherwise, dividends and (even worse) share buybacks are a tax upon the company that can become binding at the worst possible times.

2008 Nov 10 02:18 PM

[Alex Filonov:]

The only question I have: is it 1932 or 1930?

2008 Nov 10 02:19 PM

[Pipo:]

That`s why Buffett is buying. He is a diviend yield type of investor.

warrenbuffettstocks.bl.../

2008 Nov 10 02:44 PM

[msrx8ajr:]

A very high proportion of returns in range-bound markets have been from dividends. I agree with the above: you need to look at defensive businesses with lean balance sheets and reasonbly low payout ratios (room for earnings downgrades before the yield is compromised) to allow the yield to be sustainable.

Financial stocks, traditionally high dividend payers, in many cases today no longer offer dividends, so income funds will be looking to rotate away from Financials into other strongly-yielding sectors. This is against a backdrop of falling global interest rates, and thus far, reasonbly low inflation, both of which enhance the appeal of good dividend streams.

As a bit of an aside, I'm finding that many covered call writes remain attractive given that volatility in general remains high. Dividends contribute to the returns of covered call write strategies.

In the UK market I like VOD and PSON as suitable yield plays.

2008 Nov 10 09:21 PM

[msrx8ajr:]

that should say clean balance sheets

2008 Nov 10 09:23 PM

[User 232593:]

since oil has to move(more or less) & no one has figured a way to pave over the ocean,take a look @ FRO & NAT.even if the div is cut you might still get a good return.i have made out great with this stock.

2008 Nov 11 03:16 PM