Falling Dividends Mean Bonds Pay More than Stocks

Stock dividends account for 70% of after tax income since 1900 after inflation. So when dividends get cut, equities don't look nearly as attractive as bonds.

I like high dividend stocks because they offer a stable source of income and a low tax rate.  Right now, dividends are in the cross hairs of many companies looking to save cash, and that doesn't bode well for equities.

Ask most casual investors, and they'll tell you that they buy stocks for the appreciation.  But dividends account for 70% of after tax income since 1900 after inflation.  So when dividends get cut, equities don't look nearly as attractive as bonds.  According to a Bloomberg article:

"U.S. equities returned 6 percent a year on average since 1900, inflation-adjusted data compiled by the London Business School and Credit Suisse Group AG show. Take away dividends and the annual gain drops to 1.7 percent, compared with 2.1 percent for long-term Treasury bonds, according to the data.

A total of 288 companies cut or suspended payouts last quarter, the most since Standard & Poor’s records began 54 years ago, when Dwight D. Eisenhower was president. While the S&P 500 is trading at the lowest price relative to earnings since 1985 and all 10 Wall Street strategists tracked by Bloomberg forecast a rally this year, predictions based on dividends show shares are overvalued by as much as 46 percent."

Companies are cutting dividends like never before and that's bad news for the market and for equity investors. 

The dividend discount model established by Myron Gordon estimates that the S&P would have to fall to 526 before investors are compensated for adequantly for owning shares.

Two companies that aren't expected to cut their dividend are McDonald's and P&G.  According to the model, McDonald's stock is undervalued by 46%  and P&G is undervalued by 42%.

As companies slash the cash they pay out to shareholders, it makes sense that companies that maintain dividends will see a premium built into their stock price.

This chart shows the dividend yields of the 30 members of the Dow Jones Average.

Sam Cass
Sam Cass: Sam Cass, MBA, JD, University of Texas at Austin. Always a fan of Leonardo Da Vinci.

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Comments

  • JRodgers

    February 24, 2009

    Chasing stocks for dividends has never been a good strategy. We've seen that equity yields across the financial industry no longer make any sense. I don't know much about McD and P&G, but I think that many of those chasing dividends in stocks like Att, Verizon or many other companies are running tremendous risks.

  • Sam Cass

    February 24, 2009

    "Chasing stocks for dividends has never been a good strategy."

    I don't think chasing is the appropriate word. But buying stocks with strong dividends is a winning strategy - most of the time. You can't dispute that 70% of after-tax income has come from dividends since 1900. You can try and chase stock prices higher but that is a losing strategy.

  • sagitarius84

    February 25, 2009

    Sam,

    Actually Jeremy Siegel, the author of "Stocks for the long run" has found that re-invested dividends have accounted for 97% ot Total stock market returns in the US since 1871.
    Most of the dividends cut these days are from companies which are cyclical. If you look at the dividend aristocrats or the achievers have done better in terms of dividend cuts than the rest of the stocks out there.

  • Ruth

    February 25, 2009

    I will only invest in dividend stocks. I invest to make money not to gamble on price appreciation.

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