Dividends Instrumental in Past Low Equity Returns Periods
July 31, 2012
“I rarely think the market is right. I believe non-dividend stocks aren’t much more than baseball cards. They are worth what you can convince someone to pay for it.” –Mark Cuban
The “new normal” is a term coined by some in the investment community to describe the current economic environment that combines high sovereign debts with low economic growth. These two attributes build economic stress as more debt may need to be incurred to cover interest payments, low tax revenues and to help stimulate economic growth. Higher debt levels have shown to be a major impediment to economic growth so piling more debt on debt can become a destructive economic force. The “new normal” refers to the belief that we may be stuck in this environment for some time and during this time investment returns are likely to be lower than their long-term averages.
What is a solution to help counter-act this low investment return environment? Good old-fashioned, boring dividends.
Consider the following facts about how dividends helped during other low return periods.
- Without dividends, the S&P 500 index would have produced a loss for the 25 long years from August 1929 to August 1954 — the era that included The Great Depression.
- The S&P 500 produced a 5% loss during the 13 years from September 1961 to September 1974; however, with dividends added, the loss became a total return of 46%.
- The S&P 500 is down approximately 15% since the end of 1999… until you add back those boring dividends. Including dividends and the S&P 500′s 15% decline, it flips into a 6% gain.
- Over the course of the last half-century, dividends have contributed more than half the stock market’s total return — 56% to be exact.
You might consider this a pretty solid argument for high, consistent dividend payers in any investment environment but even more so as we may be mired in this sluggish economic and low return environment for an extended period.
One approach is to just buy and hold dividend paying stocks. We utilize an equity strategy that focuses on high dividend stocks but we add a few more criteria to help increase probabilities for success and provide a boost to returns in a flat market. Those criteria include:
- Focus on consistent dividend payers that have increased their dividend at least once a year for a period of consecutive years.
This proves the company has been able to maintain their cash flow and dividend through past recessions and gives the market conviction that their dividend payout will not be reduced. There are nearly 100 public companies that have increased their dividend for more than 25 consecutive years.
- Purchase companies when their sector is in a strong seasonal performance period.
History shows definitive time periods when different sectors perform better. Increase your odds by purchasing companies in sectors that are just entering their historically strong seasons.
- Do not purchase companies when their stock price is an extended price.
Purchase companies whose stock is in strong areas of technical support such as near its 50- or 200-day moving averages. This increases the likelihood that institutional buying will support the current stock price from further declines.
- Consider selling a covered call option on your high dividend position to collect an additional cash premium on your position.
This caps your potential high upside gain, but if we are in a low equity return environment, that trade-off may be worth the additional 3% to 4% of income on your position and the additional downside protection.
How long we remain in this “new normal” environment can be debated. History shows that financial recessions such as the 2008 recession requires a much longer recovery period than your typical recession so there may be some credence to the “new normal” theory. If that environment persists, then it will likely be wise to focus on high dividend paying stocks to help provide more stable returns. The past shows us that those stocks have been the star performers during the past low return environments.