Review & Outlook

Our take on the investing, financial, & economic themes of the day

Thinking of dividends

22 August, 2011 by Ben O'Brien in Commentary

Stock prices typically go up about 5% a year.  That’s the historical average.  But we all know (we all know too well) that some years stock prices don’t go up. Fortunately, though,  there’s more to stocks than just their prices.  I am of course thinking of stock dividends.  Back in the 1990s investors lost interest in dividends. Who cares about a 2% dividend when stocks are going up 15 or 20% a year?  But now, with stock prices stalled, and interest rates as low as they have ever been, dividends are starting to look very interesting.  Indeed, they are one of the few places an investor can find a secure current income while waiting for  future appreciation.

Right now the average stock dividend in the Standard & Poor’s 500-stock index pays somewhat more than 2%, which is more than the 10-year Treasury bond pays. How remarkable is that?  I entered the investment business in 1975 and I have never before seen the average stock dividend exceed bond yields.  The average one-year certificate of deposit yields .4%.  The average money market fund yields about .1%

But how safe are these relatively big dividends?  Quite safe, in my opinion.  Over most of my career the rule of thumb was this: a stock dividend was safe so long as it did not exceed 40% of a company’s average net income.  Right now dividends on average amount to about 30% of corporate net income.  To be sure one can get into trouble reaching for dividend income.  One must be prudential.  For instance, the most-at-risk sector is the financial sector; we would probably steer clear of it regardless of the dividends.  But the rest of corporate America is making record profits and the dividend payout is on the low end of the historical scale.

Mark O’Brien