Dividends; The Secret To Long-Term Returns!

Investment Strategy: "Dividends; The Secret To Long-Term Returns!"
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By Jeffrey Saut | 2 February 2009

"For investors looking for yield, we recently screened the Russell 3000 for stocks with upcoming ex-dividend dates that yield more than 4%. Because the dividends of many companies have come into question, we also only include stocks with positive expected 3-year dividend growth. The stocks have ex-dates between now and mid-March, and remember, to receive the dividend, you must own the stock by the close on the day before the ex-date." ... Bespoke Investment Group (1/28/09)*

For years we have given investors numerous successful investment themes, yet our overriding theme has been one of "income" since we believe "income" will be a profitable investment theme for the foreseeable future. Indeed, the baby boomers are retiring; and, the yields afforded them via Treasury securities, money market funds, and certificates of deposit (CDs) will not supplement their retirement account incomes enough to support them in the style to which they have become accustomed. Enter stocks, which since 1926 have averaged a total annualized return of 10.4%. Interestingly, roughly 5% of that return has come from earnings growth, 0.9% has come from price-to-earnings (P/E) multiple expansions, but 4.5% of said return was derived from dividends!

Verily, more than 40% of long-term investment returns have been driven by dividends. Further, if investors buy non-dividend-paying stocks, and the overall stock market declines, they tend to be at the mercy of the "directionality" of the stock market. However, the shares that investors purchase of dividend-paying stocks, whose share price subsequently declines, actually own an asset that is becoming more valuable as its dividend yield rises, provided the dividend is maintained.

While some contend that aggregate corporate dividends have been reduced, and/or eliminated, due to the maelstrom in the financial complex, we have recommended avoiding financials for the last five years and therefore have been relatively unaffected by those dividend reductions. Excluding the battered financials, however, finds most corporate balance sheets in relatively good shape; yet, companies remain hesitant to commit more money to capital expenditures in the current weak economic environment. Therefore, we think it reasonable to expect corporations will use dividends as an increasingly valuable strategy for distributing excess cash. To be sure, non-financial balance sheets are in better shape than the financial complexes’, suggesting that dividends, and dividend increases, should be a favored corporate strategy going forward rather than that of share repurchases, since for the last 18 months most share prices have traveled lower, making share repurchases a value destroying strategy.

To this point, most companies have two avenues for "uses of cash." They can either plow back/re-invest in capital expenditures, M&A activities, and/or working capital initiatives, or they can pay/increase dividends, repurchase shares, and/or reduce debt. Our analysis suggests that managers will probably pursue shareholder-friendly initiatives after meeting internal/external objectives. This implies they will likely pay, and/or increase, dividend streams. This is not an unimportant observation since the retiring "boomers" seem to be moving toward the mantra scribed in the first paragraph, of the first chapter, of Ben Graham’s book the Intelligent Investor, which Warren Buffett terms, "By far the best book on investing ever written."

Said quote reads, "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative." Note that Dr.Graham uses the word adequate, not "spectacular," when speaking of investment returns; a point we think investors should hold in high regard.

Plainly, secure dividends tend to cushion a portfolio and enhance total returns. Dividends also provide, at least to some degree, the "margin of safety" Ben Graham speaks of in the last chapter of his book titled "The Margin of Safety." To wit, if you own a stock with a 7% yield, those shares can decline by 7% over the next 12 months and you have not lost any money.

Consistent with these thoughts, we have employed Graham’s investing matrices in our investing strategy for more than 40 years. That is why we constantly reiterated the theme of "dividend yields." We continue to invest this way and would note that in Bespoke’s dividend-yielding stock list there are five companies from the Raymond James research universe of stocks. Those issues are: 8.8%-yielding Realty Income (O/$19.27/Outperform); 7.3%-yielding Polaris Industries (PII/$21.27/Market Perform); 5.5%-yielding NYSE Euronext (NYX/$22.00/Market Perform); 4.8%-yielding Hudson City Bank (HCBK/$11.60/Outperform); and 4.8%-yielding Aflac (AFL/$23.21/Strong Buy).*

And while they are not on Bespoke’s list, additional yielding names from Raymond James’ "Analyst Current Favorites" report include: Republic Services (RSG/$25.86/Strong Buy/2.9% yield); Johnson & Johnson (JNJ/$57.69/Outperform/3.2%); Allstate (ALL/$21.67/Strong Buy/7.6%); Inergy (NRGY/$23.36/Strong Buy/11.0%); Home Depot (HD/$21.53/Strong Buy
/4.2%); Essex Property Trust (ESS/$66.05/Strong Buy/6.2%); and New York Bancorp (NYB/$13.25/Strong Buy/7.6%).

Speaking to the equity markets, we were pretty bullish between the psychological/capitulation stock market "low" of 10/10/08 (where 93% of the stock traded on the NYSE made new yearly lows), as well as the subsequent "price low" of 11/20/08, often commenting that the stock market was in a bottoming process on a short/intermediate-term basis. Further, we were adamant that participants should favor the upside into mid-January 2009 where a correction would be due. We also opined that the stock market’s internal metrics (advance/decline, upside versus downside volume, new highs versus new lows, etc.) in that decline would tell us a lot about the future direction for stocks. Accordingly, we became increasingly defensive as the "ides of January" approached.

Since then we have been monitoring the market’s internals, but so far they are telling us nothing. The picture should become clearer if the DJIA (8000.86) can either confirm the breakdown by the D-J Transports (TRAN/2965.60) of their November 20, 2008 "low" with a like breakdown below the Dow’s November 20, 2008 closing-low of 7552.29 (so far what we have is a downside non-confirmation, which is bullish); or, if the DJIA and the TRAN can better their January 6, 2009 reaction highs of 9015.10 and 3717.26, respectively, which would be a Dow Theory "buy signal." Until then, we continue to take the market’s "temperature." Indeed, sometimes me sits and thinks and sometimes me just sits.

That said, we continue to think it is a mistake to get too bearish because of the bullish case that can be made. As stated in last Thursday’s verbal strategy comments:

1) If forward earnings estimates are anywhere close to the mark, stocks in the aggregate are cheap;

2) Nominal interest rates are zero and real interest rates a negative;

3) Money is the "oil" that makes the economic engine run and money is being printed like wallpaper;

4) Oil prices have collapsed, which is tantamount to a huge tax cut;

5) The authorities are pulling-out ALL the "stops;"

6) The official recession is now 13 months old with the typical one lasting 18 months;

7) If past is prologue, 4Q09 will end the recession;

8) The stock market tends to stop going down six months prior to recessions’ end;

9) So far the TRAN has broken below its November 2008 "low" without the DJIA doing the same (read: Dow Theory downside non-confirmation); and

10) If the DJIA and the TRAN rally above their respective January 6, 2009 closing highs, it would be a Dow Theory "buy signal."

As well, we have seen this "play" before. As Dennis Gartman wrote last week:

"There is no question that this is the worst economic time since the Great Depression" ... "Sluggish economic growth this year will cap the worst three-year period centered on a recession since the Great Depression" ... "Forecasts for a weak recovery next year suggest the period since the turn of the decade will be the worst for the economy since the Great Depression" ... "The banking industry has plunged to its lowest point since the Great Depression" ... "This is the worst retail sale period on record since the Great Depression" ... "This recession is hitting white-collar workers more heavily than any since the great Depression of the 1930s."

Those media quips were all taken from various newspapers during the recession of 1990 - 1991.

The Call For This Week: At down 8.5%, the S&P 500 just had its worst January in history. That swoon flashed cautionary signals from not only the 'January Barometer' (so goes January, so goes the year), but the 'December Low Indicator' as well. Moreover, in the past three weeks there have been three '90% Downside Days' (points lost versus points gained AND downside volume versus upside volume were skewed more than 90% to the downside), suggesting that the "sellers" have not yet been exhausted.

The result left most of the market averages we follow below their respective 10-, 30-, and 50-day moving averages, indicating a full downside retest of the November "lows" is likely in the works. Whether that retest will be successful remains to be seen, but we are hopeful because our proprietary oversold indicator is just about as oversold as it can get. In the interim we are cautiously sitting and waiting until the stock market "speaks".

*For the full Bespoke dividend list, participants should consider subscribing to the invaluable Bespoke Investment Group service.

  M O R E. . .

Normxxx    
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