Geoff Considine

Dividend investing
Geoff Considine
Dividend investing
Contributor since: 2006
Company: Quantext
This is a great theme--tracking Robo allocations--because there is no other way to see how they are doing other than putting money into these. I will look forward to future installments.
David:
Nice article. People have needed a decent estimate of all-in fund costs for quite some time. I will check out your website.
FWIW, POC helmets are very well thought of here in Colorado--especially in the mountain biking community. The argument is that they are much better at reducing concussion risk than standard helmet designs. I have no opinion on the company as a whole, though, because its not part of my universe.
When a bull market in the S&P500 has been going for a long time, you start to see more articles saying that all you need is the S&P500 (and perhaps cash or T-Bills to reduce risk). What is implied is that diversification does not matter at all. I am seeing an increasing number of these articles this year. Who needs to diversify beyond U.S. equities when U.S. equities seem to out-perform everything else? The real question is whether you can predict which asset class will out-perform ahead of time. Everyone is free to take that bet.
Where, oh where is Larry Swedroe?
Larry:
Adding Treasury bonds to a stock portfolio lowers the Beta but also lowers the exposure to the value factor--e.g. reduces the value tilt. The factor analysis performed by Alex Bryan shows that you get lower Beta and the same value tilt as for the high E/P portfolio before you ever add bonds.
Of course adding bonds increases risk-adjusted return--that's fundamental in terms of diversification benefits--but this does not really address the issue of dividend stocks vs. other value strategies.
Geoff
Larry:
You have mentioned this theme previously:
"if you are getting low beta by buying high dividend stocks, that can be replicated by using high quality bonds in combination with value stocks to achieve the same beta for the portfolio"
I actually wanted to mention this in my article, but I figured that you would be better at articulating your argument.
Please share your research on this theme. The question that needs to be addressed is whether the corporate bonds, by lowering the beta, would also lower the weighting on the value factor. In addition, once you make this a broader asset allocation question, the discussion shifts substantially. Low Beta research shows that low Beta equities out-perform, but it is a whole different argument to introduce other asset classes--especially fixed income. There are also interesting questions about the efficacy of the factor models for portfolios including bonds. If I run corporate bonds through the factor model, I bet that I will get low Beta and some loading on value because corporate bonds--but that does not mean that corporate bonds are 'value stocks'...its simply a matter of correlation.
Please expand your argument from above...
SDS:
Your link to Arnott's 'Bonds: Why Bother' is a great addition to the discussion, but I think that most people will require some additional connection. Arnott's point is that the equity risk premium is not a foregone conclusion, nor do we have perfect information in predicting the equity risk premium *going forward*. Once again, this is why estimation risk is so important.
The types of investors who buy an asset are certainly an important factor. The people buying a young growth stock with a P/E of infinity or no earnings at all are buying a lottery ticket. The people who buy utility stocks are buying a steady stream of earnings. This has been studied in the literature on 'glamour' stocks--they get lots of media and get driven way up by the hype. Sometimes they justify the hype. People who go to Vegas in the hopes of coming home as winners are the same types of people who bet that they can get a good return from fast-moving stocks. This has also been studied in the academic literature.
Larry:
When you say that screening for dividends reduces diversification with no benefit, I have to raise an important point. Your comment on diversification is the main critique that DFA raises in their paper "Global Dividend Paying Stocks: A Recent History" and you have cited this paper a number of times. There is a logical problem with this argument, however. The DFA study also shows that portfolios selected for dividends have the same annualized return and lower volatility than the total universe of all stocks. Better diversification in this total stock universe should result in higher risk-adjusted returns than an 'under-diversified' dividend portfolio. But DFA shows that this is not the case.
So, obviously there are types of stocks and industries that have little or no representation in a dividend-focused portfolio, but we have to be careful about distinguishing between this and the purpose of diversification which is to increase risk-adjusted returns. The DFA study is showing that the added 'diversification' from non-dividend stocks have no quantitative diversification benefit. This is odd.
Hi all:
Interesting additions to the discussion. I sense that there are quite a few mathematically savvy people here. That makes for a more interesting discussion.
A central theme is the problem of estimating the equity risk premium in the future. We all know the historical ERP but that does not really matter--what matters is the future ERP. When there are polls of what experts thing the ERP will be, they vary enormously because the components are so hard to predict. The dividend piece is the one that nobody argues about. It is even harder to make the case that we know what the value or size premium will be going forward.
Here is a great paper sponsored by the CFA institute:
http://cfa.is/1ax4kNx
Larry:
I think that everyone understands your points here--at least I hope so. You have reiterated them. At the same time, though you find in impossible to see, there are plenty of smart people (Bogle, Malkiel, etc.) who understand investing who continue to favor dividends for some or all of the reasons that I and others have articulated.
I certainly appreciate your continued engagement here--it is good for everyone to have their conclusions challenged. We don't disagree on basic math--I don't think that this has ever been the question here, though I can see why you may have thought so.
We continue to see the world differently on the main issue, which is whether dividends are a useful basis for selecting investments. I read the literature out there as saying that there are a wide range of reasons why dividend paying firms have higher quality earnings, less potential for agency issues, the low investor returns associated with buybacks, etc. and I continue to like dividends. The DFA study that you sent me shows that dividend payers, globally, have essentially identical CAGR with lower volatility than all stocks together or non-payers. This is, as you will note, perhaps entirely due to a value tilt associated with dividend payers. I am just fine with that. Finally, we have the issue of estimation risk, which is the topic of my part 3 of this post. I look forward to your comments.
Larry:
I am articulating in detail why I disagree with you on your argument that the fact that the four factor model explains most of the variance in return suggests that dividends are irrelevant in Part 3 of this post.
I bring up Malkiel for the same reason I brought up Bogle's support for dividend-based investing. Many of your comments suggest that any mathematically literate person has to agree with you. Malkiel is clearly a world expert. This does not mean that you have to agree with him, but certainly you will concede that there are well-reasoned people on the other side of this issue from your position.
FYI, Burton Malkiel reiterates his position that dividend-paying stocks are a good "anchor" for a portfolio:
http://on.wsj.com/1dNt1Tc
Larry:
I'd love to read the DFA paper you link to, but it is behind DFA's firewall. Could you send it to me...its hard to judge a paper that you have not been able to read.
From your summary, however, I would prefer dividend payers. Same CAGR and lower volatility--that sounds like an argument in favor of dividend payers. With the same CAGR and lower vol, this would also be much more attractive to people who need income.
Geoff <dot> considine yahoo <dot> com
Thanks,
Geoff
Larry:
Can you articulate what you mean by "nice try but it doesn't explain the outcomes correctly"? What "it"--what "outcomes."
You also said that I was "clearly wrong" about the number of shares issues--I don't know what you are referring to.
I appreciated your spirited defense of your position--even though I don't agree.
The article / analysis from Vanguard that Larry suggests as making the case for total return is an interesting choice because I wrote an lengthy piece when that came out in which I critique the thinking:
http://bit.ly/1cKGVru
Matt and Larry:
You guys are focusing on a key issue here and this was one of the key reasons that I wrote this post. For investors to be indifferent with regard to a dividend vs. reinvestment vs. buybacks, you have to make some assumptions about the rate of return on reinvested earnings and buybacks. There is a body of research in behavioral finance that shows that managers may not behave in the best interests of shareholders when making the decisions about how to invest retained earnings.
The 'simple math' issue that Larry keeps going back to is that the cash value of your portfolio does not change when a company pays a dividend. If a company has $3 in cash per share and pays that as a dividend, this does not change the financial value of your position relative to what it was before the dividend is paid. The nature of what you own is different, though, as I have tried to explain.
David C:
I actually think that companies will change their propensity to pay dividends if investors signal that this is important to them. There is a whole literature on this--the topic is the 'catering theory' for why companies pay dividends. The idea is that companies pay dividends if investors signal that they want dividends.
The shift in the propensity to pay dividends is, I believe, directly related to the fact that the majority of investors have been trained not to look for dividends as an important signal. If investors are indifferent--they have been trained to care only about total return--then why pay them? It is much easier for companies not to have this commitment to generating consistent earnings.
I was wondering when someone would ask that. I note that if you own a diversified set of individual MLPs, the case for AMLP is not there. I own a bunch of individual MLPs. I do think that AMLP is a good fund for people who don't like to deal with a lot of individual holdings.
Thanks for the comments. I agree that the comparison of the ETF to the single MLP is imperfect. That said, many investors need to make just such a choice. ETNs introduce additional credit risk, so they aren't perfect. The issue of tax filing is another, as noted. For some investors, not needing to file K-1s is worth quite a bit. To others not.
Hi Larry:
I was not suggesting that you should agree with everything Bogle says, but rather that you have stated a number of times here that it is obvious and straightforward (basic math) that dividends don't matter. If Bogle disagrees, it would stand to reason that this is not obvious to Bogle who is obvious an intelligent and immensely experienced investor.
Second, I don't understand your point about 'having it both ways.' This is a matter of estimation risk. Dividends are a very stable part of return with less estimation risk than any other. You cite DFA research showing this and there are other studies to the same effect.
Also, over the long histories used to validate value as a factor, dividends were, on average, much higher. As companies' propensity to pay dividends has decreased, there is no guarantee that the value factor you believe in will continue to perform as well as it has in the past.
Dividends are very important as a measure of earnings quality--true look-ahead estimates. You seem to not be distinguishing between looking backwards to explain returns and looking forwards. The standard factor analysis model is totally backward looking. Its very useful, but it does not include estimation risk. Are you really willing to discount the Pastor and Stambaugh research out of hand? How about the research on dividends as a predictor of earnings quality? A body of research demonstrates that estimation risk matters.
I am writing two more posts on some of the issues raised here, and I will include the relevant academic research.
Also, for what its worth, John Bogle has recently advocated dividend-paying stocks:
http://bit.ly/KmAl0E
Larry, I know that you are a Boglehead...thoughts?
Hi Mostserene1:
The general bias against dividend-oriented investing has a lot to do with the current standards, training, and regulations. The curriculums for becoming an advisor or CFP etc. all emphasize total return--this goes back to the 50's and the Modigliani-Miller dividend irrelevance hypothesis. Very influential in academic finance. It takes decades for new theory to get into practice and while recent research clearly suggests that dividends and price gains are different, there is an old-school framework that starts with perfect market efficiency and ignores all of behavioral finance and a range of more recent studies. This old-school approach is taught to every CFP and advisor. Oddly, if you go back before the efficient market stuff took over, there was a big emphasis on dividends then.
Just my thoughts here...
I agree that you can almost always get more income with a sequence of monthly or other short calls. For most income investors and certainly most advisors, the combination of time to execute, increased complexity in taxes, and transaction costs makes this type of shorter-term strategy prohibitive.
If you thought that I was somehow endorsing Goldman's comments, I think that perhaps you should re-read the piece.
Thanks for all of the comments. I am not surprised that not everyone agrees. If everyone agreed, we wouldn't have markets. I fully agree that small cap stocks may be over-valued, but that is not really the point. I am not making a market timing call--more like an actuarial bet in terms of combining things that typically behave in different ways with respect to interest rates.
I also agree on fundamentals and the Fed, but the reality is that speculation about when the taper will happen is just that. We simply don't know. My read is that the Fed is very concerned about the lack of growth reflected in inflation numbers--far below their target of 2% per year, as well as the fact that the unemployment drops come with a huge reduction in labor participation and low-quality jobs.
We could end up like Japan with lower bond yields or we could end up with inflation and the Fed trying to cap it. Personally, I don't see much of a recovery, like Yellen et al, but the financial markets seems to have become decoupled from that reality. So, I like to hedge my bets and managing quantitative exposure to Treasury yields is a reasonable way to do it.
I agree with the sentiments expressed that this is a signal of irrational exuberance. When we no longer need to hold cash and we should all jump in...well, its all about keeping the merry-go-round going.
Ajay:
I had a quick look at BUI. Be aware that a significant chunk of that 'yield' is actually return of capital. In other words, they are just giving you your money back. Morningstar breaks out CEF distributions for CEFs this way--very useful to track.
Jarco:
I get your point. That said, for income investors, the goal is realized income rather than maximizing all available return potential. The combination of dividends with call premium is hard to beat. As I mentioned above, in my experience, when a call buyer exercises early, they give up time value on the option which means more income for the seller--e.g. the position is freed up and you keep the premium. I have often been surprised by how much value these call buyers give up.
Also, have a look at the research paper I link to by Annan that shows that options on low beta stocks are over-valued (implied vols are higher than realized volatility) as compared to growth.
In general, when a position is called away it is because the stock is rising, so I find that you can frequently do better by buying something else rather than re-buying. If you really want to keep the same position, you can sell the option a bit further out of the money to ensure that you get a return bump from a price gain.
Jack:
I was at Langley and interned in a wind tunnel way back as an undergrad.
With regard to early exercise of options, that does happen by people attempting to capture the dividend but the time value that they give up and you get to pocket often makes this still look good. I have been surprised by how often this happen.