Friday, December 19th, 2008
We’ve recently come to recognize the herd mentality that’s been corralling the minds of retail investors and how this has led to a ‘bubble’ in U.S. Treasuries. This phenomenon reflects the extreme risk aversion that’s moving the markets these days and how people are more focused on return of investment than return on investment.
Even though the yield on Treasuries is at historically low levels, investors are willing to sacrifice the returns they need for the sense of security they want. Unfortunately, this fixation with ‘safe’ assets doesn’t make much sense within the context of long-term goals.
Let us now look at the other side of the Treasuries phenomenon. In their quest for certainty, many investors may be unwittingly ignoring dividend yields on stocks, which have become more compelling as a result of the downturn in global markets.
The Dividend Yield
As dividend investors, we have recently noticed that the dividend yield on the S&P 500 Index is greater than the yield on U.S. Treasury bonds for the first time in 50 years!
Case in point, the dividend yield on the S&P 500 as of the end of November was about 3% versus the yield on the 10-year Treasury which today, is about 2% (the 2-year Treasury is yielding about 0.70%). What’s more, this isn’t just a U.S. phenomenon. In Europe, the yield on stocks also currently exceeds the yield on government bonds.
Of course, dividends are a key part of total returns (price appreciation plus investment income, including dividends). The fact that dividend yields are high relative to Treasury yields right now makes the case for dividend-paying companies that much more compelling.
If we look back to the period between 1974 and 1982, the performance of the S&P 500 was sluggish on a price return basis. But if you look at what happened as markets began to recover, including dividends in the returns that investors earned as they emerged from a period of economic uncertainty and capital market weakness (i.e. looking at total return) made a significant difference.
Herding To Safety
Today, the desire for safety runs the risk of driving ‘the herd’ off the edge of the proverbial cliff as people abandon their long-term goals in favor of short-term stability. But despite what the headlines might suggest, the world isn’t two- dimensional.
That is to say it’s not just risky assets or safe assets. To see the total picture, including why dividends need to be a key consideration in the investment process, is a starting point to having better, more robust conversations in today’s uncertain environment.
Posted in Stock Studies | 4 Comments »
Friday, October 10th, 2008
What We Have Learned
It is very important when investing to not only evaluate a company against others in its sector or industry, but also against itself.
In previous articles, we have discussed the dividend payout ratio, free cash flow, Z-Score and Return on Invested Capital (ROIC). All of these metrics are used as a way to evaluate stocks against their peer group, but also against themselves at different points in time.
When we have narrowed a company down against its peers, it is then time to evaluate the stock against itself at different points in time. Doing this can help us to determine if a stock is selling at a reasonable price.
How To Use Average Dividend Yield
One of the greatest ways to evaluate a dividend stock against itself is to determine the average dividend yield that that stock has paid over the past number of years. If the stock has a higher than average yield, compared to its historical average, then it may indicate that it is a better time to purchase shares (all other factors being equal).
There is an excellent tutorial on calculating average dividend yield at DividendsMatter.com. I will highlight some of the main points here, but I highly suggest that you read the full tutorial.
First of all, I like to gather 10 years worth of data for the stock. This is easy to do because the stocks that I analyze have very long histories of paying dividends. The information we need is the high and the low stock price, and the dividend paid out for each of the last 10 years.
This data can be gathered from many sources, including the company website. However, I prefer to use Yahoo Finance because the dividend information can be filtered out from the stock price using this option.
This is all the historical information we need. Now, from this information, we can calculate the high yield and the low yield for each year. The high yield is calculated by taking the annual dividend and dividing by the low price. Similarly,the low yield is calculated by taking the annual dividend and dividing by the high price.
High Dividend Yield = Annual Dividend / Low Stock Price
Well Worth The Effort
The mathematics of the process is very elementary, but it does take some time to gather the information. This is certainly time well spent and I suggest that you practice on a couple of your favorite stocks.
You will find that buying high quality, dividend growth stocks at prices above their average dividend yield will give you a margin of safety and confidence to hold the stock through thick and thin.
Obviously, this is one metric of many that will help guide you in your quest to buy quality dividend growth stocks.
Please see: How To Choose Dividend Growth Stocks . for additional learning.
Posted in Investor Education | 3 Comments »
