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Re-Reading "A Random Walk Down Wall Street" By Burton G. Malkiel (27 April 2012)

One of first book on investing I read ~ 15 years ago was "A Random Walk Down Wall Street" by Burton G. Malkiel. Prof. Malkiel is well known proponent of index fund investing. Under this and few other good books influence I invested (and still keep a big chunk of my 401K) in S&P500 index fund. But from 2006 I transformed myself in eclectic dividend investor (see my SA profile).

I'm reading 2007 edition "A Random Walk Down Wall Street" by Burton G. Malkiel - it seems even he agrees now (or I didn't put attention in the beginning of my investment journey) that dividend deliver 90% of total stocks return in the long run (see chapter 13 of the book). So keeping in mind that I'm biased to dividend investing, let analyze Prof. Malkiel on dividend. He points that grow rates of earnings and dividends (including stocks buybacks in recent years) are very similar and Prof. Malkiel mostly uses earnings (this is probably really better because not all companies pay dividends). Simple observation of 2 diagrams reproduced below (figs 1and 2) with common knowledge that dividends are paid out of earnings do not leads to any surprise: return on cheap stocks (low P/E or high dividend yield) are higher than on expensive stocks and small difference in actual numbers can be IMO neglected.

Fig. 1.

Fig. 2.

Prof. Malkiel points about fig.1 (fig. 2 was constructed similar):

"The diagram was produced by measuring the dividend yield of the broad US stock market (in this case, the Standard & Poor's 500-Stock Index) each quarter since 1926 and then calculating the market's subsequent ten-year total return through the year 2005. The observations were then divided into deciles depending upon the level of the initial dividend yield. In general, the exhibit shows that investors have earned higher total rates of return from the stock market when the initial dividend yield of the market portfolio was relatively high, and relatively low future rates of return when stocks were purchased at low dividend yields."

Then he comes to strange conclusion:

"Finally, note that this phenomenon does not work consistently with individual stocks. Investors who simply purchase a portfolio of individual stocks with the highest dividend yields in the market will not earn a particularly high rate of return."

But each deciles (one tenth) of S&P500 is by definition contains only 50 stocks - quite reasonable number for investor's portfolio (my is more than 2X large). I guess Prof. Malkiel is too biased to index investing.

I agree with Prof. Malkiel notes related to dividend growth investing:

"… growth at 15 percent rate means that dividends will double every five years… The catch is that dividend growth does not go on forever, for the simple reason that corporations and industries have life cycles similar to most living things."

See for an example of business life cycle. My analysis of David Fish list of companies that increse dividends for several years (fig. 3) shows that dividend growth decline with period of rising dividends.

Fig. 3

I agree with Prof. Malkiel notes related to dividend capturing investing:

"A good deal of research has also been done on the usefulness of dividend increases as a basis for selecting stocks that will give above-average performance. The argument is that an increase in a stock's dividend is a signal by management that it anticipates strong future earnings. Dividend increases, in fact, are usually an accurate indicator of increases in future earnings. There is also some tendency for a strong price performance to follow the dividend announcement. However, any rise in price resulting from the dividend increase, although perhaps not immediately reflected in the price of stock, is reflected reasonably completely by the end of the announcement month."

BUt I need to admit that dividend capture is very risky business.

At the end I'd like to use quote Prof. Malkien cites:

"In investing money, the amount of interest you want should depend on whether you want to eat well or sleep well./ Kenfield Morley "Some Things I Believe" "

I believe the dividend investing helps me sleep well.

The lesson I hope you'll learn from this review: use your own mind and be critical when you read finance books, even an excellent one as "A Random Walk Down Wall Street" just because an author can have own sometimes hidden agenda which is not coincide with your best interest.