Tuesday, March 18, 2008

* Dividends Are Gold in a Down Market

In a down-market when many people are rushing to buy gold, I already have mine. No, not that kind, but something much better! A stable stream of dividend income from solid companies. While everyone else is panicked about their portfolio's decline, I see the downturn as an incredible buying opportunity.

I am certainly not the first to recognize the power of buying good dividend stocks when they are down. The 'Dogs of the Dow' is probably the most popular implementation of this strategy. Michael O’Higgins popularized this strategy in his book, Beating the Dow (1991 and 2000). In O’Higgins' implementation he invests in the 10 highest yielding securities in the Dow Jones Industrial Average (Dow), and rebalances annually. He back-tested the strategy by looking at the 26-year period from 1973 to 1998. During that period the 'Dogs of the Dow' outperformed the Dow, earning 17.9% annually versus 13.0% for the Dow.

Granted the 'Dogs of the Dow' strategy is not a traditional buy and hold dividend investing strategy, but it does emphasize the power of dividends when combined with good solid companies. For a more traditional dividend investing example let's look at one of my favorite companies, General Electric (GE), and consider these facts:

Year Price Divi. Yield2000 $60.50 $0.57 0.9%
2003 $32.42 $0.77 2.4%
2008 $34.33 $1.24 3.6%

For 2000 and 2003 above, Price represents GE's high stock price for the year. For 2008 Price is GE's closing price on 3/17/2008. For all three years, Divi. is the annual dividend paid per share and Yield is Divi./Price.

I included 2000 above since that was the year GE's stock hit its 10-year high at $60.50. The current yield of 3.6% on 3/17/2008 is four times the 0.9% in 2000 at the stock's high. GE was an excellent company in 2000, as it is today, but now the dividend is quadruple the 2000 level.

What if you purchased GE 5 years ago at 2003's high of $32.42? You would have purchased it when the yield was a decent 2.4%, but you would have only seen 5.9% share appreciation (in absolute terms). However, the Yield On Cost (YOC) goes from 2.4% in 2003 to very respectable 3.8% in 2008, slightly above 2008 current yield of 3.6%. This increase was a result of GE increasing its dividend 10% on average from 2000-2008. Hypothetically, if GE were to increase its dividend 10% a year for the next 10 years the dividend would be $3.22 in 2018, with a YOC of 9.4% on shares purchased in 2008. Not bad for top tier company.

It is easy to see why a down market does not depress me. There's gold in them-there hills!

Related Articles: