Dividends: The Secret to Long-Term Returns

Excerpt from Raymond James strategist Jeffrey Saut's latest essay, published Monday (February 2nd):

...For years we have given investors numerous successful investment themes, yet our overriding theme has been one of “income” since we believe “income” will be a profitable investment theme for the foreseeable future. Indeed, the baby boomers are retiring; and, the yields afforded them via Treasury securities, money market funds, and certificates of deposit (CDs) will not supplement their retirement account incomes enough to support them in the style to which they have become accustomed.

Enter stocks, which since 1926 have averaged a total annualized return of 10.4%. Interestingly, roughly 5% of that return has come from earnings growth, 0.9% has come from price-to-earnings (P/E) multiple expansions, but 4.5% of said return was derived from dividends!

Verily, more than 40% of long-term investment returns have been driven by dividends. Further, if investors buy non-dividend-paying stocks, and the overall stock market declines, they tend to be at the “directionality” of the stock market. However, the shares that investors purchase of dividend-paying stocks, whose share price subsequently declines, actually own an asset that is becoming more valuable as its dividend yield rises, provided the dividend is maintained.

While some contend that aggregate corporate dividends have been reduced, and / or eliminated, due to the maelstrom in the financial complex, we have recommended avoiding financials for the last five years and therefore have been relatively unaffected by those dividend reductions. Excluding the battered financials, however, finds most corporate balance sheets in relatively good shape; yet, companies remain hesitant to commit more money to capital expenditures in the current weak economic environment.

Therefore, we think it reasonable to expect corporations will use dividends as an increasingly valuable strategy for distributing excess cash. To be sure, non-financial balance sheets are in better shape than the financial complexes’, suggesting that dividends, and dividend increases, should be a favored corporate strategy going forward rather than that of share repurchases, since for the last 18 months most share prices have traveled lower, making share repurchases a value destroying strategy.

To this point, most companies have two avenues for “uses of cash.” They can either plow back / re-invest in capital expenditures, M&A activities, and /or working capital initiatives, or they can pay / increase dividends, repurchase shares, and / or reduce debt. Our analysis suggests that managers will probably pursue shareholder-friendly initiatives after meeting internal / external objectives. This implies they will likely pay, and / or increase, dividend streams.

This is not an unimportant observation since the retiring “boomers” seem to be moving toward the mantra scribed in the first paragraph, of the first chapter, of Ben Graham’s book the Intelligent Investor, which Warren Buffett terms, “By far the best book on investing ever written.” Said quote reads, “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” Note that Dr. Graham uses the word ADEQUATE, not “spectacular,” when speaking of investment returns; a point we think investors should hold in high regard.

Plainly, secure dividends tend to cushion a portfolio and enhance total returns. Dividends also provide, at least to some degree, the “margin of safety” Ben Graham speaks of in the last chapter of his book titled “The Margin of Safety.” To wit, if you own a stock with a 7% yield, those shares can decline by 7% over the next 12 months and you have not lost any money.

Consistent with these thoughts, we have employed Graham’s investing matrices to our investing strategy for more than 40 years. That is why we constantly reiterated the theme of “dividend yields.” We continue to invest this way and would note that in Bespoke’s dividend-yielding stock list there are five companies from the Raymond James research universe of stocks. Those issues are: 8.8%-yielding Realty Income (O); 7.3%-yielding Polaris Industries (PII); 5.5%-yielding NYSE Euronext (NYX); 4.8%-yielding Hudson City Bank (HCBK); and 4.8%-yielding Aflac (AFL).*

And while they are not on Bespoke’s list, additional yielding names from Raymond James’ “Analyst Current Favorites” report include: Republic Services (RSG); Johnson & Johnson (JNJ); Allstate (ALL); Inergy (NRGY); Home Depot (HD); Essex Property Trust (ESS); and New York Bancorp (NYB).

Speaking to the equity markets, we were pretty bullish between the psychological / capitulation stock market “low” of 10/10/08 (where 93% of the stock traded on the NYSE made new yearly lows), as well as the subsequent “price low” of 11/20/08, often commenting that the stock market was in a bottoming process on a short / intermediate-term basis.

Further, we were adamant that participants should favor the upside into mid-January 2009 where a correction would be due. We also opined that the stock market’s internal metrics (advance / decline, upside versus downside volume, new highs versus new lows, etc.) in that decline would tell us a lot about the future direction for stocks...

...[W]e continue to think it is a mistake to get too bearish because of the bullish case that can be made. As stated in last Thursday’s verbal strategy comments: 1) If forward earnings estimates are anywhere close to the mark, stocks in the aggregate are cheap; 2) Nominal interest rates are zero and real interest rates a negative; 3) Money is the “oil” that makes the economic engine run and money is being printed like wallpaper; 4) Oil prices have collapsed, which is tantamount to a huge tax cut; 5) The authorities are pulling-out ALL the “stops;” 6) The official recession is now 13 months old with the typical one lasting 18 months; 7) If past is prologue, 4Q09 will end the recession; 8) The stock market tends to stop going down six months prior to recessions’ end; 9) So far the TRAN has broken below its November 2008 “low” without the DJIA doing the same (read: downside non-confirmation; and 10) If the DJIA and the TRAN rally above their respective January 6, 2009 closing highs, it would be a Dow Theory “buy signal.”

The call for this week: At down 8.5%, the S&P 500 just had its worst January in history. That swoon flashed cautionary signals from not only the January Barometer (so goes January, so goes the year), but the December Low Indicator as well. Moreover, in the past three weeks there have been three 90% Downside Days (points lost versus points gained AND downside volume versus upside volume were skewed more than 90% to the downside), suggesting that the “sellers” have not yet been exhausted.

The result left most of the market averages we follow below their respective 10-, 30-, and 50-day moving averages, indicating a full downside retest of the November “lows” is likely in the works. Whether that retest will be successful remains to be seen, but we are hopeful because our proprietary oversold indicator is just about as oversold as it can get. In the interim we are cautiously sitting and waiting until the stock market “speaks.”

Comments

[tipalia:]

maybe it s one of the reasons that Bill Gates owns a big chunk of RSG.
I wonder what % of RSG shares that he already owns?
And it looks like he is still buying more.

Feb 03 08:24 AM

[bernie 1:]

Was it a year ago or more,things have moved so fast, time and dividends are a blurr. All the rocket scientists told us,buy big, buy smart,get the dividends and wait out the downturn. Buy Citi,Bac,Aig,Macy's.Th... giants will keep us afloat until this ecomonic downturn is through. Even Mr. Buffet had to sell because of some of the fertilizer that he bought. I'm no rocket scientist,I bought a Closed End Fund that holds 29% Berkshire Hathaway in it.If I have to do investing after I pay off my margin account, I'll do my own homework--------Thanks for all the advise!
Your's in povety
Bernie

Feb 03 08:53 AM

[dsrtwriter:]

While the theory of dividends providing some stability is reasonable, if you had bought some of the high dividend stocks a month or so ago you have already "lost" the dividend benefit. They are still stocks, and one still has to examine the overall market and make some judgement on whether it is going up or down from here. Sure, it is a coin toss, but unless you really must be in stocks in the next few months, might be better to just follow some of these dividend payers and buy when the whole index takes a dive.I don't think we are done yet and think we will see Dow 6000-6500 before it is over.Earnings are going to keep falling and that will impact PEs and PEGs and price will have to adjust downward.

There is also the question of companies suspending the dividend, and that will happen more and more.

Feb 03 03:31 PM

[mediapro:]

I have been looking long and hard for either a non-financial dividend-focused ETF, a closed-end fund of the same or a garden variety common or preferred stock mutual fund and can't seem to find one that's not sector focused (usually utilities).

Are there any brilliant SA'ers that can help?

Feb 03 04:13 PM

[socphd71:]

Buyer Beware! Some of these stocks aren't making enough profit to continue their dividend. Others are in industries (e.g., banking, motorcycle manufacturing) with gloomy outlooks.

Feb 03 08:18 PM

[Airelon Tra...:]

I really wouldn't call BAC, or C, or AIG diversified, or the biggest last year.

The ones to buy are your aristocrats bluechip. JNJ, PG, KO and stocks the like. Companies that produce something. I bought a bit of BAC at $30.55. But then again - I made sure it was only 3% of my overall portfolio. Gotta stick to money management ...

Airelon


On Feb 03 08:53 AM bernie 1 wrote:

> Was it a year ago or more,things have moved so fast, time and dividends
> are a blurr. All the rocket scientists told us,buy big, buy smart,get
> the dividends and wait out the downturn. Buy Citi,Bac,Aig,Macy's.Th...
> giants will keep us afloat until this ecomonic downturn is through.
> Even Mr. Buffet had to sell because of some of the fertilizer that
> he bought. I'm no rocket scientist,I bought a Closed End Fund that
> holds 29% Berkshire Hathaway in it.If I have to do investing after
> I pay off my margin account, I'll do my own homework--------Thanks
> for all the advise!
> Your's in povety
> Bernie

Feb 03 10:55 PM

[a. palmer jr.:]

I bought 4 "dividend" stocks last year. All 4 cut their dividends when things got rough. All of them are cash rich companies, they just don't distribute to stock holders now.

Feb 03 11:21 PM

[Dave Wrixon:]

If you want long-term returns, you need to pick a company with a Management that has long-term vision. You also need to be able take short-term set backs in your stride.

Long-term dividends require the development of products that are accurately targeted against the future and evolving needs of a rapidly changing society.

The team needs to do the R&D to get the edge on the competition to deliver products way ahead of anything currently on the market, and to bring them to market with a passionate zeal, whilst of course maintaining adequate cost control throughout.

So, it is not about market technicalities or current balance sheets or anything tangible in the market at all. It is about finding teams of people with ideals, skills, motivation and vision. And ongoing revenue streams will require the structure and capacity to constantly reinvent and renew the organization.

Anyway, if you want to find any of this stuff, stay well clear of Wall Street Analysts. Most of the them could not recognize a winning plan presented on a silver platter.

Feb 04 04:04 AM

[claudio.lan...:]

The article is antiquated in light of the current market conditions. As previous posters have noted billion dollar banks are basically insolvent. Dividends have been cut or eliminated. Many companies which were stalwarts of industry are no longer in existence. For people investing under the old mentality your time has passed and if you continue to invest based on the past your in for a rude awakening and a lightening of your retirement account.

Feb 04 10:59 AM

[Dividend Gr...:]

Claudio,

Your response is very far from the truth. Asides from a few exceptions the only companies cutting dividends are financials. There are a ton of stocks raising their dividends, right under your nose.

Owning small portions of good businesses you understand (also called shares) has always been the way to prosper in this country. Few if any people have made much money with active trading ( now I exclude money managers and brokers, who make money no matter what by charging you commissions)




On Feb 04 10:59 AM [e-mail] wrote:

> The article is antiquated in light of the current market conditions.
> As previous posters have noted billion dollar banks are basically
> insolvent. Dividends have been cut or eliminated. Many companies
> which were stalwarts of industry are no longer in existence. For
> people investing under the old mentality your time has passed and
> if you continue to invest based on the past your in for a rude awakening
> and a lightening of your retirement account.

Feb 06 08:17 AM

[JCCIII:]

Adding to the comments above concerning companies cutting dividends. I do not currently own any financial stocks, but several of the non-financial dividend stocks I do own have recently cut their dividends substantially. Somewhat less anecdotally, SPY's dividend fell 2007-Q4 to 2008-Q4 from $0.7754 to $0.7193.

Feb 06 12:51 PM

[JCCIII:]

I would add that, even despite the 7.23% (assuming I did the math correctly) reduction in SPY's year-over-year dividend, I still do concur with the premise of the article; that dividends are a significant long-term driver of positive investment returns.

Feb 06 12:56 PM