Last Day Of The Year: Examining Dividends

 |  Includes: DVY, SPY
by: Roger Nusbaum

Jason Zweig had a writeup over the weekend about dividends that covered a lot of ground. It included an interesting point of view from the CEO of Diamond Offshore (NYSE:DO) who talked about the extent to which dividends reward shareholders (we've all heard that one before) as opposed to stock buybacks, which he said rewards the people selling (that's a different way to articulate it). There is, of course, some benefit to existing shareholders from stock buybacks, but this particular CEO seems to really care about how shareholders are treated.

Dividends play a huge role in the long-term success of a portfolio. There are various statistics floating around about how much of the total return of equities comes from dividends. The numbers are big, but I have seen several that vary widely so you can do your own digging here and pick the number and time frame you think makes sense.

As we have gone over many times before, dividends are not the top priority here vs. protecting the bottom-line number of the portfolio. But dividends are still very high on the list of things we care about.

My thinking here is that adding an extra 100-200 basis points in dividends vs. the benchmark means the rest of the portfolio may not have to work as hard (meaning not take on as much risk or volatility), but there comes a point where too much yield means more risk is being taken. That line in the sand is not something someone else can define for you, although, in my opinion, going above 7%-8% for the entire portfolio would be past the point of more risk, and really I would not want to be at 5%-6% for the entire portfolio. I have hard time getting to 4% while still maintaining what I think of as being a properly diversified portfolio. These days there are a lot of stocks with yields in the threes but not the fours. We have some with 5%-6% yields, but we also have some with little to no yield. A 4% yielding portfolio can be built; it would just not be as diversified as I would like.

In 2012, dividend stocks as measured by dividend ETFs, lagged regular market cap weighted indexes. The iShares Dividend ETF (NYSEARCA:DVY) is up 4.95% on a price basis so far this year vs. 11.58% for SPY. DVY out-yields SPY by 154 basis points (according to Google Finance), which of course doesn't come close making up the difference.

I don't cite that example to make the case that dividend investing is bad, but it is an interesting development because of how popular dividend investing has become. On a related note, I've been leaning toward the current stock market and economic cycles ending in 2013 or early 2014 as a function of normal cycle longevity. One market behavior that would support this as a leading indicator would be quality doing better. This usually means large cap outperforming small cap, although the difference between SPY and IWM in 2012 has been negligible. It will be interesting to see whether this general idea will have relevance between large cap and dividend indexes. All of this might be saying that the cycle will not end in 2013; 2014 would be well within the realm of normal.

Obviously, the current events in Washington have the potential to be the most important determinant of what happens in 2013.