Sunday, November 23, 2008

Dividend Yield and T.Bond rate

The last few weeks have seen their share of the strange and the unusual. Last Wednesday, another milestone was reached. The dividend yield on the S&P 500 exceeded the 10-year treasury bond rate for the first time since 1958; just to add, the dividend yield went up only because stock prices have dropped so much this year. So. what is the significance of this occurrence?

a. The Bargain Basement view
: If we assume that dividends are stable - and they have been remarkably predictable for the last few decades - investing long term in stocks seems like a no-brainer. The income you get from the dividends is greater than what you would make investing in treasuries, and when stocks eventually recover, you get the upside of price appreciation as well.

b. Dividends will drop: The counter to this viewpoint is that the recession and a desire for liquidity will cause companies to cut back on dividends. When they do, it is argued that this aberration will disappear.

I tend to agree more with the first viewpoint than the second. After all, companies in the US have not increased dividends much over the last 40 years and chosen instead to buy back stock. Last year, stock buybacks accounted for two thirds of the cash returned by corporations. I believe that companies that are facing hard times and desirous of liquidity are more likely to reduce stock buybacks than cut dividends.

However, I would fine tune the strategy. I would focus on companies paying high dividends - the list is long - and have little debt & large cash reserves. The collective dividend yield on these companies will be higher than what you can make on most safe investments currently...


Mberenis said...

I like this blog, the layout is great! Did you hear about the new bailout and financial assistance programs for citizens and immigrants??

Bailout and Financial Assistance for USA Citizens and Immigrants

What do you think? I like it.

evileconboy said...

How about your favorite class example, Con Ed?

Aswath Damodaran said...

Glad to see that someone has been following my classroom examples. Here is the big difference> There have always been individual companies that have traded at dividend yields higher than the rikfree rate. This is the first time in 50 years that the entire market has traded at this level.

evileconboy said...

Of course, one might say we are really in Case B, and can you really think 3M (yield just about equal to the 10 year) and other economy sensitive companies are going to maintain their dividend in an environment of a shrinking economy where banks won't lend to anyone?

Better to stick with the Con Eds and Microsofts of the world whose dividends are relatively secure in that case.

shikhil said...

You are right that dividends of US companies have been relatively stable over past 50+ yrs; companies always want to have stable dividends. But this itself cannot justify that in future companies can sustain same level of dividends.

Dividend yields of S&P going higher than 10yr Trea. is itself a once in 50+ year event (as you have mentioned), so i won't be shocked if i see companies cutting dividends, again a once in 50 year event.