Let’s take things one step at a time here:
<<It’s a fallacy to add up the dividend yield and the earnings yield to arrive at a likely return over time,>>
Really? John C. Bogle, founder of the Vanguard group, would disagree with you. There are really only three variables that go into the stock price equation: earnings, dividends, and the multiple the market is willing to pay for it. If you assume–as you seem to in your previous post–that eventually these multiples will regress to a historic average (say, 14 x trailing earnings for the S&P), then that leaves you with a determinate of earnings + dividends.
Over long periods of time, I think that’s a pretty reliable indicator in the aggregate.
<<because dividends are paid out of earnings.>>
<<Every time a stock pays a dividend, the price of the stock is adjusted down to reflect that payment in recognition of this.>>
EARNINGS (and EPS) are adjusted to reflect the payment of a dividend. Not the share price. For example, if a dividend-paying company were to abruptly cut its dividend without explaination, the market would undoubtably cut the price of the stock.
If a company suddenly increased its dividend, the market would not adjust the price of a share downwards, as you state, but upwards.
<<So the projected return, over time, of stocks based on the current earnings yield is only 3.82% per year.>>
Yeah, but that’s a stupid way to make the projection. Why make projections based on a “current” ANYTHING in the absence of an anticipated growth rate? And why deliberately leave dividends out of the equation? Or price multiples, for that matter (though they’re impossible to predict.)
The historic rate of return on stocks is nearly 3 TIMES your projection. Don’t you think there might be something wrong with your model?
<<In practical terms, this means that even if the earnings yield on stocks is less than the yield on Treasuries.>>
There is no reason to omit dividends on stocks from your equation. Current earnings + dividends on stocks are currently superior to 10 year treasuries (which I feel have largely been bid up already. The vanishing surplus will also sap longer treasuries of the percieved scarcity value they had 1-2 years ago, when the U.S. was buying back 200 billion of them and pushing the far end of the yield curve downward. If you’re running to bonds now, you’re too late. The time to buy bonds was in late 99 and early 2000.)
Another thing to consider: Dividend income is worth much less than capital gains on the stock, thanks to taxation. Dividends are taxed as income every year, where capital gains can be deferred indefinitely, and paid only once when gains are realized, at a much lower rate than income. Since 70-80% of stock gains are capital gains and not dividends these days, stock returns tend to be of higher value to the stock holder than dividends on bonds.
>>And as far as I’m concerned, BTW, projections of earnings are worthless. The only thing that counts is what it’s making NOW.<<
I talk to professional money managers every day about their investment methodology–people at the very top of their profession, who manage billions and tens of billions of dollars. I don’t know a single one who would agree with you.
I couldn’t give a rat’s patootie about what it’s making before I buy it. The only thing I care about is what I believe it will be making AFTER I invest. Indeed, for micro caps and new businesses, I’d rather invest before it makes any money. It matters not a whit to me what the company is making now. What matters is do I believe that this company will be worth more in five or ten years from now than it is today?
<<No one can predict the future.>>
Nonsense. If you’re an investor, it’s your JOB to predict the future. Nobody gets it right all the time. But you can get it right enough to make the effort useful. Me? My prediction is that over the next 20 or 30 years, stocks will A.) be higher than where they are now, and B.) outperform bonds on a total return basis, and C.) do so more tax-efficiently.
I am investing accordingly, mostly via broad index funds.
<<The only thing you really have to go on is how whatever you’re looking at has done,>>
So no one can ever rationally invest in new businesses?
<<and then deciding for yourself if it will continue on the same path. >>
I thought you said noone can predict the future!
<<Usually, if earnings are declining, the P/E will fall too, because projections of growth will get revised downward>>
A.) Wrong. P/E multiples RISE as earnings decline.
B.) I thought you said that growth projections are worthless? Now you are implying that growth projections and stock prices are correlative! Imagine that.
<<Combine a fall in earnings with P/E contraction, and you have a formula for a truly vicious bear market.>>
Only if you buy and sell at the wrong times. I didn’t buy a blessed thing in 1999 and 2000.
<<Not something you hear a lot about.>>
On the contrary, it’s all I hear about now. It’s all over the covers of popular financial magazines. Market sentiment is very low, which is a powerful bullish indicator. That’s why I’m now buying.
<<A far better measure than projected earnings and one of the best ways to figure out your chances on a stock is to look at the dividend, because it is a measure of the faith the management has in the business.>>
Quite the opposite.
A dividend is a statement by the company that they aren’t aggressively trying to grow the business anymore. It’s also a way of transferring the tax burden from the business onto shareholders.
<<A lot of people (not including Scientoligist or yourself, natch) don’t even think about looking for stocks that have a history of both paying a dividend and of increasing that dividend year after year, as MO does. Ever heard of Summit Properties (SMT)? It pays a dividend that at its current price amounts to about 7%, increases it every year. A beauty.>>
ONLY for income oriented investors. For me, it’s a tax nightmare. With interest rates so low now, why is it this REIT can’t profitably reinvest that 7% to grow the business? If the management doesn’t think that investing in itself is the best use for capital, then who am I to second guess them? If I don’t need the income, then why should I invest anything here? I would probably look elsewhere.
Don’t get me wrong–SMT’s a great company and 58% total return in 2000 is no slouch. But whether it’s a beaut or not depends on the shareholder’s situation and portfolio.
<<<All the talk is always about Cisco or Nortel or some other glamorous tech stock. But if you look at the price action on this one, you wouldn’t even know a bear market was going on. (This is true of a lot of REITs, not just this one.) And I have never once heard it mentioned on CNBC or Wall Street Week or seen it featured in Barron’s. >>
Funny, the monthly consumer publication I work for has written at least two spreads on REITs this year.
<<<But you have to be willing to do the work to find them. >>
I thought you said “no one can predict the future?” How do you find them without making a prediction? Or do you just wait until the price has already gone up to buy?