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SDS (Seductive Dividend Stocks)
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Sorry I hide my true identity but I'm a physicist/engineer, native contrarian and idea generator. I am an eclectic dividend investor with motto "In God We Trust, All Others Pay Cash" applied to companies I invest in. I like to read /and read a lot - did you look on my SA photo 8-)? /... More
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  • Illustrative Comment To "Asset Allocation For A Dividend Growth Investor" By David Van Knapp (10 Feb. 2012) 12 comments
    Feb 10, 2012 4:08 PM
    David Van Knapp wrote excellent article "Asset Allocation For A Dividend Growth Investor" (seekingalpha.com/article/349011-asset-al...

    I'd like to comment using the graphs below. I'm a dividend investor and now all my money are in stocks. I always ask myself "Am I right?" and the mentioned article forces to ask once again.

    Let me start from my thoughts about asset allocation. David Van Knapp considered stocks, bonds and cash and pointed that bonds are not needed for dividend growth investor who has steady but not sufficient income (pension and SS). The "ground zero" asset class - cash should be always available for emergency, etc. and comments to the article show no doubt in it and I agree. So 2 asset classes are left. David Van Knapp argued that for a Dividend Growth Investor (NYSE:DGI) bonds are not needed.

    Stocks and bonds are not only possible assets classes. Nowadays, financial advisers propose now long list of so-called "alternative investment" classes on the top of bonds and stocks. They also recommend rebalance between them on regular basis.
    I think this is quite dangerous for investor because
    a) nobody deeply understand several assets classes (even with ETFs) an investor just plays Russian roulette if (s)he puts money on the table without proper knowledge;
    b) the main purpose of rebalance (hidden market timing) is to generate cash for financial advisers.

    As far as I understand assets allocation approach tryes to minimize fluctuations of prices. Theoretically any 2 classes with anti-correlated prices should fit an assets allocation model if investor need to take "cream" (well, RMD, for example, see note 1 below) from investment on regular basis.
    If an investor goal to have income stream (seems most important during retirement) the investor might not worry about prices of dividend growth stocks but should worry about inflation. In contrast to standard assets allocation approach income stream and inflation should be strongly correlated.

    But is dividend growth rate (DGR) in synx with inflation? The only really long term study I aware of shows that they are not (see figure from "Value Investing: Tools and Techniques for Intelligent Investment" book by James Montier).

    As far as I understand this graph represent ALL stocks in US, probably trend is different a set of companies which pay rising dividends but there is no insurance that some such companies reduce or omit dividends.

    If we look on S&P500 stocks only (data from American Association of Individual Investors - Download Library, Historical Market Data) for last few decades we can see that after about 1966 stocks yield in average was smaller than inflaton while bonds provided better than inflation return:


    As you can see long-term bonds in last 25 years provided inflation insurance. Now in 2012 bond yield is so low that such insurance disappears,

    The following figures show DGR (trailing 12 months) versus inflation graphs for large- middle- and small-caps S&P stocks I created from from American Association of Individual Investors - Download Library, Historical Market Data.

    The pictures above show that it is hard for a stock-income investor to handle inflation during a market depression when many companies cut their dividends. Again sets of large- middle- and small-caps S&P stocks and dividend growth stocks are not the same although some stocks are in both sets.

    I also plotted 3- and 10- years averages (figure below) by readers request. It seems that DGI works for a decade timeframe but a protection (2nd asset class?) is needed for an investor with smaller patience.

    I choose 3 years because I hold cash for 3 years in case of any emergency (e.g. unemployment which is still high in California) and 10 yers per your email. 10-years picture for 1956-mid 2011 is in favor of DGI while 3-years isn't. I guess 5 or 7 years will be good for DGI but I don't think it make sense to have cash for more than 3 years of regular expenses. So again probably 2nd assets class is needed for middle term type of disaster.

    I think a pure DGI should have broad diversification between stocks in different capitalization categories with high yield and relatively small DGR and stocks with DGR well above average inflation in all cap categories.
    Another practical conclusion from the last graph is not to spend and re-invest all dividends from DG stocks in good years and safe some money for rainy days.

    Probably 2nd asset class (not necessary bonds) is needed for DGI during high inflation. Should it be gold or something more exotic for inflation? I don't know... That I know is the facts that inflation in some countries was well above 100% and even 1000% (to compare with ~ 20% worst in USA recent history) and as far as I remember from book "Triumph of the optimists: 101 years of global investment returns" by Elroy Dimson, Paul Marsh, Mike Staunton the government bonds of these countries were worthless in hyperinflation periods. Fed. monetrary policy in last few years makes hyperinflation possible in USA, esp. if China and other countries switch off US debt and US dollars.

    The situation for pure DGI is even worse during deflation. Companies cannot increase price of their products and probably demand is also drops. So during deflation earnings and therefore dividends should decrease. Again probably 2nd asset class (bonds?) is needed for DGI during long deflation. I'm not aware about behavior of diferent assets during deflation - might be Japanese experience is helpful but I have no clue what is/was going there.

    Note 1: Required Minimum Distribution (NYSE:RMD) calculator /pointed in a comment to the article/ requires about 4% withdraw at age 70 and 8% withdraw at age 90. I think that DG stocks portfolio with good initial yield (e.g. 3% for 62 y.o. investor) and reasonable DGR can provide enought "cream" (dividends) in order not to touch capital.

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  • G.Ray
    , contributor
    Comments (189) | Send Message
     
    Thanks for the research. The conclusion(s) one might draw based on the charts could vary. If you have the source charts, and not just pictures, it might be useful to redraw the lines using moving averages, maybe a ten year moving average. That certainly would show less variability along with more obvious trending.
    10 Feb 2012, 01:01 PM Reply Like
  • SDS (Seductive Dividend Sto...
    , contributor
    Comments (3182) | Send Message
     
    Author’s reply » Thank you G. Ray!. DVK also proposed to use 10 years averages.
    I calculated the same S&P500 DGR vs CPI inflation for 10 and 3 years periods and post in the blog update. I choose 3 years because I hold cash for 3 years in case of any emergency (e.g. unemployment which is still high in California) and 10 yers per your email. 10-years picture for 1956-mid 2011 is in favor of DGI while 3-years isn't. I guess 5 or 7 years will be good for DGI but I don't think it make sense to have cash for more than 3 years of regular expenses. So again probably 2nd assets class is needed for middle term type of disaster.
    10 Feb 2012, 01:28 PM Reply Like
  • Lawrence Weinman
    , contributor
    Comments (1075) | Send Message
     
    3 years of cash(i.e. insured CDs or tbills) is what I recommend for retirees or those approaching major expenses like tuition. It's a fairly common recommendation by those derided financial advisors. I also look at VFIIX for this money depending on the interest rate situation.
    11 Feb 2012, 09:57 PM Reply Like
  • G.Ray
    , contributor
    Comments (189) | Send Message
     
    Thanks for the update, and your point is well taken.
    10 Feb 2012, 05:39 PM Reply Like
  • Lawrence Weinman
    , contributor
    Comments (1075) | Send Message
     
    Fantastic article, I am working on a similar one but you have done great work. Not only should you have submitted this as a premium article it should be an editors choice your numbers demolish a simplistic strategy. I am putting in my two cents with the editors that recommends they do so.

     

    congrats again
    11 Feb 2012, 12:34 PM Reply Like
  • Smarty_Pants
    , contributor
    Comments (2781) | Send Message
     
    "The situation for pure DGI is even worse during deflation. Companies cannot increase price of their products and probably demand is also drops. So during deflation earnings and therefore dividends should decrease."

     

    To expand on this point, the US has not seen deflation lasting more than a few quarters since the 1930s. For such short duration events the impact to earnings and dividends is negligible. Any truly significant deflation would collapse the current economic structure until bad investments could be liquidated and put to use for better purposes, based on the changing demands of consumers.

     

    Squiggly lines on a chart do not begin to portray the impact of a meaningfully different economic environment.

     

    Given the immense growing total debt burden relative to the current US GDP a true deflationary event would result in widespread bankruptcies and much higher levels of unemployment. Interest rates would go much higher and demolish any fixed term debt based asset value. Portfolio values would be crushed all around. See current day Greece for an example of this process as it happens.

     

    The typical DG stock would probably fare better than most alternate investment choices in such circumstances. Shareholders whose stock survives such economic conditions, who continue to receive dividends, will probably be far better off than the 40 year old with a wife and two kids and little or no savings, that just got a pink slip.

     

    If a massive deflation sets in and consumer spending slows to a trickle, which company do you expect to fare better at generating profits: Proctor & Gamble or Open Table?
    11 Feb 2012, 02:59 PM Reply Like
  • SDS (Seductive Dividend Sto...
    , contributor
    Comments (3182) | Send Message
     
    Author’s reply » Lawrence Weinman

     

    I tried submit another more serious article (http://seekingalpha.co...) I promissed in few my comments but it was rejected because my English isn't perfect (indeed - it is not my native) and Editors& I don't have resources to polish language. Because I'm not looking to profit from SA I think instablog is good enough for me to share my thoughts.

     

    SDS
    11 Feb 2012, 08:16 PM Reply Like
  • SDS (Seductive Dividend Sto...
    , contributor
    Comments (3182) | Send Message
     
    Author’s reply » Smarty_Pants

     

    All graphs show that was in the past. I have no clue that will be in future. I don't think that Greece experience is applicable to USA but I concern about debt and to whom US own. On global perspective assuming no cardinal changes in world economy probability of long deflation in USA is small in my amateur opinion.

     

    IMO, Open Table will sink early and faster than P&G in case of long inflation many famous companies in DGI portfolios will cut dividends and many DGI will sell stocks at fire.

     

    SDS
    11 Feb 2012, 08:25 PM Reply Like
  • Lawrence Weinman
    , contributor
    Comments (1075) | Send Message
     
    The probability of deflation is small and I'm sure you think the probability of high inflation is low.

     

    But interest rates are at or near all time lows on 10 year Treasuries,short term interest rates are near zero, the S&P 500 is coming off one of the worst decades in history, the country is in the midst of the worst recession since the great depression, the largest financial institutions had to be bailed out by the govt.while record number of smaller banks went bust,...

     

    And dividend yields are above Treasury yields for the first time in 40 years.....
    And most of the DG folk think they have found a foolprioof investing strategy to use for the next 30 years based on extrapolating current conditions. With one of its key assumptions that DG stocks are a substitute for bonds.

     

    I know " it's different this time" and it's time to change long term strategies based on historical data.
    ....it almost always is.

     

    Think about it
    11 Feb 2012, 10:06 PM Reply Like
  • SDS (Seductive Dividend Sto...
    , contributor
    Comments (3182) | Send Message
     
    Author’s reply » Well I invested a lot of my valuable time to fully understand dividend stocks traded in USA. I'm not ready to change my investment style until somebody proofs me with data that something is 2X better. Historical data show that dividend stocks are quite fine - see my other instablog posts.

     

    I disagree with "With one of its key assumptions that DG stocks are a substitute for bonds." I think David Van Knapp tried to show that his pension+SS are a kind of substitute for bonds for an old person who die before bond maturity.
    13 Feb 2012, 08:59 AM Reply Like
  • SDS (Seductive Dividend Sto...
    , contributor
    Comments (3182) | Send Message
     
    Author’s reply » OK I found the following quote author, sorry for delay.

     

    Government bond might come a “return-free risk” (Jim Grant)

     

    Look on German government bonds in XX century
    15 Feb 2012, 06:53 AM Reply Like
  • SDS (Seductive Dividend Sto...
    , contributor
    Comments (3182) | Send Message
     
    Author’s reply » David Van Knapp in 2012 edition of his book (published in Jan 2012) wrote at page 150:
    "You may be thinking that I am going to say that all of your retirement assets should be in dividend-growth stocks. I am not. I believe in many of the fundamental tenets of asset allocation—so I believe that there is a role for cash and bonds in a retiree’s portfolio. But with that said, I also believe that there is a far larger role for dividend growth stocks in retirement planning than they are usually given."
    I think it is more correct point of view that he gave in the article under discussion, although to some extend pension+SSA payment mimic bonds.
    18 Feb 2012, 11:23 AM Reply Like
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