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Dividends are no longer merely a welcome add-on to a rising stock price; they’re essential

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November 19, 2008 – Comments (10)

 

I came across one of the best articles on investing in today's market that I have seen in a while last night while perusing Smart Money magazine.  It was Jack Hough's monthly piece.  I've always enjoyed his articles on screening for stocks, so much so that I purchased his book Your Next Great Stock (of course, I have yet to read it).  I have been unable to find a link to the article on-line.  It may only be in the print edition, so I have taken the time to physically type in an outstanding quote from it and to summarize the rest (that's how much I care about CAPS ;) ).

"Investors who stay in the market are doing the right thing – it’s still the best way to make money long-term.  But change your strategy.

There used to be sheep in Manhattan’s Central Park.  They were evicted in the 1930s, though not because after 70 years they had become troublesome tenants.  Rather, city historians say that during the Great Depression, when more than a quarter of workers couldn’t find jobs and the nation’s hungry and homeless built shack towns in public spaces, the sheep were feared too tempting a meal.

America has seen far worse than the next few years will bring.  That’s not to say that stocks will recover quickly: Investors should be cautious, since losses in the financial economy have yet to fully affect the broad economy.  Plus, despite appearances, the broad market’s value might be merely fair and not illogically cheap.  But a handful of companies now carry the slimmest valuations and richest dividend yields seen in a generation."

According to Hough, S&P 500 index currently sits at around 13 times trailing aggregate earnings.  That is an attractive level when compared to the S&P 500's historic average multiple of 14.5, and especially when compared to the crazy 19 multiple that it has averaged over the past twenty years.  Unfortunately, he points out and I concur that most analysts are still too optimistic about companies' future earnings.  In the post World War II era, after-tax corporate profits have averaged  5.9% of GDP.  However corporate profits had ballooned to an unsustainable level over the past several years.  At the beginning of 2007, they had grown to over 10% of GDP.  These statistics are enough to make one look at this year's 39% drop in corporate profits a little differently.  Perhaps this is more of a return to a normal, sustainable level of profits than a temporary dip in earnings.

One has to be particularly pessimistic that profits will return to their recent highs when one looks at what sort of shape the U.S. consumer is in and how we got here.  After adjusting for inflation, the average income of American families has not grown in more than thirty years, but fueled by cheap credit and soaring stock / home prices consumer spending has exploded.  The recent precipitous fall in home prices and walloping that most investors' portfolios have taken, combined with a tight credit market should is and will continue to cause consumer spending to drop significantly. 

Having spewed all of this doom and gloom, it's time for some optimism.  I strongly believe that a fairly significant economic slowdown is priced into stocks at their current level.  While some are scared off by high dividend yields, they often are a sign of a bear market bottom.  Historically bear market bottoms are often reached when companies' dividend yields rise to 5% to 6%.  Unfortunately, the S&P 500 currently yields only 3%.  That isn't as bad as it initially looks though because stock buybacks are much more popular today than they have been in the past.  If the money that companies were spending on buying back shares was spent on dividends, the yield would be around 5% to 6%, which is a buy signal.

I strongly believe that now is a good time for investors to dip their toe into the water and to begin buying stocks again.  Don't throw all of your money into the market immediately looking for a quick recovery.  Things will take time.  Average in a little each month looking for companies with big dividends and even bigger free-cash-flow yields to help ensure that those dividends keep coming.

Deej

10 Comments – Post Your Own

#1) On November 19, 2008 at 3:15 PM, garyc27 (< 20) wrote:

Thanks for the work to post this information.

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#2) On November 19, 2008 at 4:46 PM, TMFDeej (99.40) wrote:

You're very welcome, Morgan.

Deej

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#3) On November 19, 2008 at 6:23 PM, columbia1 wrote:

Nice job!!, (and to top it off,18 recs in three hours).

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#4) On November 19, 2008 at 8:21 PM, nuf2bdangrus (< 20) wrote:

PFF   my favorite play.  Buy close to 20 as you can.  Avoids specific stock risk

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#5) On November 19, 2008 at 8:43 PM, bullshiite (31.81) wrote:

I definitely agree that high dividend paying, large cap, companies are the best investment to make if you want to buy stock.  I do not, however, agree with your analysis that the market has bottomed because the S&P now yields 3%.  When I ask myself: is the American economy going to hear goods news before it hears bad news?  I unfortunately fear that the latter is going to be in the headlines well into the 1st quarter of 2009.  So I can not justify purchasing stocks before: A) GM, Ford, and Chrysler resolve their financing problems, B) The 'worst-potential' holiday season for the retail sector is behind us, and C) Some stabilization of the housing crisis in seen.  I predict that the Dow will hit 6,500 before it hits 10,000.  Perhaps at 6,500 the high-dividend stocks will be worth the risk.  I would advise everyone, who is considering investing, to at-least wait for the holiday season to pass.

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#6) On November 19, 2008 at 8:46 PM, Tastylunch (29.27) wrote:

After adjusting for inflation, the average income of American families has not grown in more than thirty years,

It's even worse when you factor in that most families have two  spouses  employed outside the home now ....

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#7) On November 19, 2008 at 10:53 PM, Option1307 (29.75) wrote:

I agree things are cheap right now, extremely cheap in regards to the last ten yrs. However, I agree with bullshiite that there is way to much uncertainty in the market right now. Buying now may result in calling the bottom and having a significant return; however, I much prefer to wait some more until things stabilize. Even if I "miss" the bottom and lose out on a few extra gains, so be it, at least I avoided another potential 20/30% loss.

I honestly see no reason why to buy now. How can people be so optomistic about the historical cheapness of stocks when the Big 3 are on a lifeline, job losses are increasing drastically, and this holiday season is going to be horrid. If one if these scenarios comes to play, don't we crash another 10-20-30%?  Doesn't all of this spell disaster? Maybe I'm just a little too chicken, but I'm not buying just yet.

 

Good thoughts Deej, thanks for the post, much enjoed as usual...

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#8) On November 20, 2008 at 12:44 PM, Bupp (28.52) wrote:

FYP:  Cash flow is essential

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#9) On November 20, 2008 at 8:20 PM, greenwave3 (47.04) wrote:

Today Altria (MO) hit a 10% yield. Enjoy!

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#10) On November 20, 2008 at 8:53 PM, TimothyVR (< 20) wrote:

That was thoughtful and helpful. I am new to this, and it's interesting to see how important dividends are. I must admit I was not as aware of it as I should be.

As a New Yorker born and bred, I also enjoyed the photo of the sheep in Central Park. I grew up with my grandparents' descriptions of the park during the depression years. In these days of tumult it's good to think about something else even on a financial site.

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