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Jubak's Journal Recent articles: • 5 stocks smart insiders are buying, 12/21/2005 • Stocks for the 2006 commodities crunch, 12/20/2005 • Global growth means a risky 2006, 12/16/2005 More... | Jubak's Journal The dark side of the dividend boom More companies are boosting payouts, supporting stock prices and delighting investors. One hitch: dividends leave less to reinvest, and growth takes reinvestment. By Jim Jubak Dividends made a comeback in 2005. And it looks like the trend is here for the long term. After bottoming at 1.12% in March 2000, the yield on the stocks in the Standard & Poor's 500 ($INX) has climbed to a recent 1.83%. That's still far shy of the historical average yield of 3.92% for the period that began in 1925. But, according to recent projections by Boston money manager Eaton Vance This swing of the pendulum from historic lows to something like the long-term average will do more than just put more dollars into the quarterly dividend checks that companies mail out. It will change market volatility, shift the relative desirability of stock sectors and change the growth rate in the economy as a whole.
Let's take a look at the difference this dividend comeback will make over the next five years. Lower stock market volatility It's not a coincidence that the bursting of the stock market bubble and the low dividend yield for this market cycle both came in March 2000. Historically, dividends have acted to put a floor under stock prices and provide investors with a decent return even when stock prices are headed south. Related news and commentary on MSN Money So, for example, in the 10 years from the beginning of 1966 to end of 1975, a truly dismal period for stock investors, the S&P 500 averaged a total return of just 3.3% a year, according to Ibbotson Associates' long term data on the stock and bond markets. (By the way, the total return in real dollars was even worse in that period, since inflation averaged 5.7% a year.) But think how bad the total return on stocks would have been for that period without dividends. The dividend yield for those years, again according to Ibbotson, averaged 3.47%. Take away dividend payments (and the return investors got from reinvesting those dividends), and capital appreciation -- the increase or decrease in the price of stocks -- averaged just 1.42% a year. When stocks pay out 5.37% in dividends, as they did in 1974 after and because of the market plunge that year (large company stocks fell 29.72%, Ibbotson says), some investors will decide to hold on rather than sell. And that dampens the market's fall. This incentive wasn't in view in 2000 when such stocks as Intel In fact, I suspect that the lack of significant dividend yields on the stocks that make up the Nasdaq Composite ($COMPX) is one reason that it has taken so long to recover the ground it lost in the bursting of the bubble. Paltry dividends kept many value investors from buying these stocks -- and value investors play a critical role in the recovery of any heavily damaged stock price. (The Nasdaq 100 Index ($NDX.X), which includes the big-cap Nasdaq stocks, has fared even worse than the Composite index. It lost 83% of its value from its peak in March 2000 to its bottom in October 2002. Today, the index is at about 35% of its 2000 peak. The Composite's value is 44% of its 2000 high.) The return of patient investors A decent dividend yield is the underappreciated foundation of long-term, buy-and-hold investing. You've all heard some version of this advice: No investor who has held onto stocks for 15 years has ever showed a loss for the period. And only two 10-year periods -- 1929 to 1938 and 1930 to 1939 (the years of the Great Depression) show a loss, according to Ibbotson data. Even then, the loss is relatively small: An annual 0.89% for 1929-1938 and an annual 0.05% for 1930-1939. But that rule is only true because of the historical dividend yield of 3.92% -- and the way dividend yields rise when stock prices decline. Take away the average dividend, and, suddenly, long-term investors in the 15-year periods that began in 1927, 1928, 1929, and 1930 lost money. And the 15-year period that began in 1960 comes close to showing a loss. Looking at 10-year returns, investors don't have to go back to the Great Depression to see that without the historical average dividend yield of 3.92%, it is possible to lose money with a 10-year holding period. It happened in 1965-1974, in 1966-1975 and in 1969-1978. That's not ancient history. A shift toward large-company stocks Want a decent dividend these days? Pretty much forget about finding one among the common stocks of any sector besides utilities. And the pickings aren't that great among utility stocks anymore, either. Because utility stocks have run up so much -- the Dow Jones Utilities Index ($UTIL) is up nearly 22% so far in 2005 after climbing 25.4% in 2004 and 24% in 2003 -- the dividend yield on the index had fallen to 3.15% as of Dec. 16. As large companies raise their dividends to something closer to the historical average, the gap with utility yields will close and large-company stocks will become more attractive. History suggests that large-company stocks rather than small-company stocks will benefit most from this dividend effect. I say "suggests" because it is difficult to construct a small-company index that accurately represents the characteristics of what most investors think of as small-cap stocks. But the data from the Russell indexes is a decent indicator of the difference in yield between big- and small-company stocks. The large-cap Russell 1000 Value Index ($RLV.X) shows a yield of 2.5% right now; the small-cap Russell 2000 Value Index ($RUU.X) shows a yield of 1.7%. And large companies are more likely to have free cash flow that they can use to more quickly raise future dividends than small companies, which are often in the capital-consuming early stages of their growth. This dividend differential is important. As Baby Boomers retire, they will be looking for yield and more willing to trade higher-but-uncertain capital appreciation for lower-but-more-certain dividend income. A bad omen for growth Why dividend yields fell so low in the 1990s and why they're on a rebound now are open questions. The cuts in taxes on dividend income pushed through by the Bush administration have helped put the dividend back on the table as a shareholder-friendly corporate strategy. The 2003 Jobs and Growth Tax Reconciliation Act reduced the top rate on taxes on dividends to 15% from near 39%. The new rate is a 70-year low. But that doesn't seem to be all that's going on. In the 1990s, dividend increases failed to keep pace with rising stock prices, at least partly because companies thought they had better uses for their cash flow. When the potential return from reinvesting cash in the company seems high, companies are more reluctant to distribute cash to shareholders. It's logical: If the return on reinvested capital is high, it is actually to the long-term benefit of shareholders for the company to refuse to pay out dividends and instead keep that cash for its own reinvestment. From this perspective, the drop in the dividend payout ratio in the 1990s was a tribute to corporate optimism about the opportunities for growth that they saw in that economy. Something like the reverse of that thinking is playing a role in the recent growth of dividend payouts. Despite the strong economy, companies have been curiously reluctant to spend money on capital equipment and expansion. Corporate cash levels are climbing. The technology sector is a key example. Investors think of this sector as the home of go-go growth companies, always looking for ways to raise cash to exploit the endless opportunities ahead of them. But, Standard & Poor's says, the 78 technology companies in the S&P 500 are sitting on roughly $140 billion in cash. Large institutional investors are starting to wonder if maybe there is a capital-spending problem. Back in September, 50% of global fund managers in a survey told Merrill Lynch I can understand why. One effect of the new global markets where, overnight, a Chinese or Indian company can build a factory and undercut an established competitor's prices -- killing profit margins -- is that investing in production is riskier than ever. (It's also more essential than ever. If a company doesn't invest in constantly reinventing its factories and workforce, it becomes increasingly vulnerable to global competition. That, however, is another story.) In the 1990s, too many dollars reinvested by companies led to huge overcapacity and a stock market crash that decimated major sectors of the technology economy so badly that they're still struggling to recover. In the current decade, too few dollars reinvested by companies could lead to more jobs going to overseas competitors and to lower economic growth in the United States somewhere down the road. Somewhere in here there's a balance. Let's hope that the current dividend comeback finds it. And meanwhile, I think investors looking to outperform the market will pay more attention to stocks with decent and growing dividend yields in the years ahead. New developments on past columns "The best odds in Las Vegas": After drifting lower from the end of July through Monday, shares of Station Casinos Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For suggestions to help navigate the treacherous interest-rate environment see Jim's new portfolio Dividend stocks for income investors. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Station Casinos. | |||||||||||||||||
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