OK.
First, your consumer publication should be commended on its two spreads on REITs. Barron’s even did two stories this week that heavily emphasized dividends. Maybe the tide is turning! I’ll know it’s time to sell out of SMT and buy some highly speculative IPO when I see CNBC start running regular features on the merits of dividend paying stocks.
Second, I have to correct you on the facts. It IS a fact, and you should know this, that a share’s price is reduced every time a dividend is paid. This takes place on the ex-dividend date. If you buy the stock before that date, you get the dividend. On and after that date, you don’t, and the opening price for the stock on the morning of the ex date is adjusted down by the amount of the dividend. It’s treated kind of like a miniature split on the stock.
It is, therefore, simply a statement of fact, not a point of debate, that the earnings yield on a stock or on the S&P is what you should use to compare it to a riskless investment such as a Treasury. You’re engaged in double counting if you take earnings + the dividend to do the comparison, or to make projections as to the long-term growth rate of the stock market. It is legitimate to take the current earnings yield and add the projected growth rate of those earnings to arrive at a conclusion as to what the return will be, however, which is I believe what you’re doing. I choose not to do that, though. You think it’s stupid not to, and you would not be alone in that judgement. Most people would think it rather stubborn of me.
That said, the point of owning a business is to extract cash from it at some point. If you were the operator of your own small business, this is what you would be vitally interested in. You are still the owner of the business, in theory, when you buy a stock, even if you’re not participating in the day-to-day operation of the business. Being interested in the cash it can pay you is, I would think, the whole point of owning the stock. It is for me, anyway. (I’m not really alone on that, but sometimes I feel like I am.)
Consequently, my decision on whether to buy is based heavily on the actual past record the management has in raising both earnings and the dividend. I know the ads say past performance is no indication of future performance, but if you’ve got a company that’s managed to raise its dividend payout every year since its IPO, or every year for the past 75 years or something (Wrigley, for instance) it doesn’t take any special predictive power to think that record will continue, because that past record is telling you you’ve got a management that knows its onions.
I should state that I think there should be no difference in the tax rates between dividends and capital gains, but I have a longstanding grudge against any kind of differential taxation based on the assets a person decides to own. As far as I’m concerned, it’s a subsidy to people who make a certain set of decisions as to what to do with their money over people who make a different set of decisions, and it distorts the marketplace. My strong opinion is that taxing capital gains at a lower rate than ordinary income merely increases the volatility of the stock market for no good reason. But that’s another thread.
As far as projected earnings, I realize I’m alone on this. But I have no faith in my fellow man’s predictive powers. As to stock prices and projected earnings being correlative, well, this too is simply a statement of fact. It doesn’t mean I think there’s anything to an analyst’s projection of a company’s earnings. It merely means that the market, because the market is in the business of making decisions based on projected earnings, will adjust downward when projected earnings are adjusted down. Let’s say a stock projected to earn 10% more in profit over the next year will have a p/e around 20. If the earnings projection gets knocked down to 5% a year for the foreseeable future, the p/e would drop to 10 and the price of the stock would drop accordingly. Something like this happens a lot to stocks, and they get these huge one day downdrafts as a result. Ditto for the indexes, although with them it usually happens over time, not all at once. The big risk in the market today is that projected earnings will decline even more than they have already because of an expectation not just of recession, but of a prolonged recession, and neither I nor China Guy think the market has fully adjusted to this yet.
Also, you should note that you get no argument from me about what the next 10 years will be like. I happen to think they’ll be great, economically speaking. But I think there’s a probability the market will conclude there will be a prolonged recession sometime in the near future, in which case it would be wrong, and at that point I’ll be buying like mad. This IS based on one simple fact: the market is not too hot at predicting recessions, but very good at predicting recoveries. My opinion is that this happens because of the heavy emphasis on capital gains over dividends, which makes stock prices more volatile and makes everyone insecure and jumpy. So going against the market when it thinks things will be bad is not taking too big of a chance.
Predicting the future, I know. Sorry, couldn’t help myself. 
Damn, Phantom, some stream of conciousness there.
First off, I said there is about a 50% chance that the market will go down significantly from here.
You might ask Bill Gates about owning a business to extract cash from it via dividends. Microsoft doesn’t pay dividends. Bill Gates has become extremely wealthy based solely on stock price appreciation.
But hey, I’m not trying to tell you what to invest in. I won’t go into the rest of it. Fight the power.
Hmm, I wonder why pantom thinks it is that the U.S. stock market had the greatest run in its history in the 1990’s even as dividend yields of the S&P 500 plummeted to 1.38%?
At this stage in my life, I’d much prefer to invest in a company that uses any surplus cash to buy back its stock than to create a dividend.
Throw in another name with Bill Gates in the “capital appreciation” camp. No less an authority than Warren Buffett’s in agreement with me. Warren Buffett’s Berkshire Hathaway has never paid dividends. As long as Buffett’s in charge, it’ll be a cold day in Hell before it does. Buffett has better things to do with shareholder’s money. Pantom, by your focus on dividends rather than total return, you would have missed out on the greatest investor in the world, and paid more than your share of taxes on top of that.
What’s more, Buffett’s hardly a glamorous bubble stock mania kind of investor.
<<<It IS a fact, and you should know this, that a share’s price is reduced every time a dividend is paid. This takes place on the ex-dividend date. If you buy the stock before that date, you get the dividend. On and after that date, you don’t, and the opening price for the stock on the morning of the ex date is adjusted down by the amount of the dividend. It’s treated kind of like a miniature split on the stock.>>>
Ok, I’m with you there. You are correct.
<<It is, therefore, simply a statement of fact, not a point of debate, that the earnings yield on a stock or on the S&P is what you should use to compare it to a riskless investment such as a Treasury.>>
Sorry. Not interested in anything except total return. And I want as little of that to be in dividends as possible. Stock prices follow projected earnings + anticipated dividends. I am not interested in value formulations that ignore one side of the equation or the other.
Here’s John C. Bogle, founder of the Vanguard Group, on this very matter:
The total return on stocks is the simple product of their investment return plus their speculative return. Investment return consists of the dividend yield on stocks plus the annual rate of earnings growth. Speculative return is the impact on stock prices of a change in the price investors are willing to pay for each $1.00 of earnings (the “price-earnings ratio”).
So no less an authority than John C. Bogle agrees with me: it is not appropriate to exclude dividends from stock returns when calculating future returns.
Here’s a link to the rest of it:
That was long, wasn’t it? Sorry 'bout that…
Sigh.
All I have to say right here is, I jinxed myself. SMT was down 6 or 7% today; they warned on earnings. The bear market has arrived, in my portfolio!
Damn!
Good luck, fellas. Once again, sorry I rambled.
Below, as long as we’re trading links, a link to a good article on the Motley Fool re bear markets:
http://www.fool.com/specials/2001/sp011002.htm?source=eheyhopop001101&ref=yhoolnk