?| Featured Author: Monica Jalife, CFA?|
A Brief Background on Dividends
Dividends have been a critical component to overall equity returns since the mid 1920s. This contribution has changed with market cycles and throughout different time periods, ranging from over 50% in the 1940s and 1970s to 14% in the bull run of the 1990s. On a cumulative basis, dividend income has contributed 41% to total equity returns from 1927 to December 2010.
Dividends: a Stable Source of Income
Dividend income provides a stable source of income that can partially offset market price depreciation during down markets. In addition, as a recent Credit Suisse study shows, dividend paying equities?have outperformed non-dividend paying equities over long time horizons and have generally achieved this outperformance with lower overall levels of volatility!
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Past performance may not be indicative of future results. ?Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by PWM Advisory Group, LLC [?PWM?] or the author), or any non-investment related content, made reference to directly or indirectly in the presented article will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.
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Another important aspect of dividend investing is the compounding effect of dividend income. For instance, if you invested $1 on January 1, 1930?in the S&P500, your investment would have?grown, excluding dividends, to $49 by December 2009. That same investment would have returned $1,259 over the same investment horizon if the dividends were reinvested .
Why is Now a Good Time for Dividend Paying Stocks?
Baby-Boomers are Approaching Retirement
Several factors support the case for dividend investing. First, let?s look at demographics. According to the U.S. Census, the first baby boomers turned 65 years old in 2011. This particular group will increase at a rapid pace, reaching 78 million in the next 20 years. As these 78 million baby boomers approach retirement, investors? focus will shift from capital appreciation strategies to equity-income strategies. As a result, I anticipate there will be strong demand for high quality dividend paying equities that provide a stable stream of income throughout different economic cycles.
Our Low Yielding Environment Calls for a New Income Solution
Next, let?s discuss the current yield environment. ?The yield on a 10 year U.S Treasury recently declined to 1.5%, interest in money market funds is close to 0% and inflation is running close to 2.5%. On an inflation adjusted basis, Treasury bond investors are actually settling for negative real returns! This historically low interest rate environment has forced many income oriented investors to look to dividend paying stocks as a new way of supplementing income and preserving purchasing power.
Dividend Yields vs. Bond Yields
Dividend yields currently exceed bond yields by the most in 15 years. Not only do many companies pay dividends in excess of the ten year Treasury (close to double), but they also have the potential to grow their dividends over time. Dividend payout ratios, the ratio of dividends paid to earnings generated, are at their lowest levels in years; and with healthy profit growth projections and high levels of cash balances, companies are well positioned to increase their dividend payments.
Dividend Paying Stocks Are Cheap Compared to Bonds
Looking at current valuations, dividend paying stocks?(and stocks in general) also appear historically cheap when compared to bonds. One way to compare the relative attractiveness of stocks versus bonds is to compare the earnings yield of the market versus bond yields (see chart below).
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Past performance may not be indicative of future results. ?Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by PWM Advisory Group, LLC [?PWM?] or the author), or any non-investment related content, made reference to directly or indirectly in the presented article will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.
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As of May 31st, the earnings yield for the S&P 500?(earnings the companies in the index are generating as a percentage of the price) was 7.5 % compared to the 10 year government bond yield of 1.6%. When the earnings yield of the S&P 500 is less than the current 10 year government yield, bonds are more attractive in relation to stocks. Conversely, when the earnings yield is higher than the 10 year government bond yield, stocks are considered undervalued in relation to bonds. The chart below shows that this spread is at its widest level in 30 years, which suggests that stocks are very cheap when compared to bonds.
Dividend Paying Stocks Should Not Be Ignored
To conclude, the importance of dividends cannot be ignored. Over time, dividend income has comprised a significant portion of long term stock gains. It also represents a more stable component of total return that can partially offset market depreciation in down markets.
A well constructed portfolio of dividend paying equities can provide attractive current income and allow for capital appreciation.?Demographics, valuation and the current yield environment are all factors and trends that support the bullish case for dividend stocks.
Due to various factors, including changing market conditions and/or applicable laws, the presented material(s) may no longer be reflective of current opinions or positions. The thoughts and opinions expressed in the presented material(s) relate only to the author and are not?necessarily?reflective of PWM?s views. Moreover, you should not assume that any discussion or information contained in the presented material(s) serves as the receipt of, or as a substitute for, personalized investment advice from PWM. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.?Photo Credit:?kenteegardin ? flickr
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