Falling interest rates have turned age-old investment rules of thumb upside down. Professional investors often compare the dividends of stocks to the income that a bond might pay. Bonds typically pay more income than stocks. This is generally accepted by investors as they traded in the potential for growth of a stock for the potential of higher income with a bond.
It is important to note that when investing in a stock, total return is calculated by finding the change in price of the stock and adding the dividends paid during the holding period. As companies came to rely less and less on dividend payments to attract investors in the 80s and 90s, the total return focus became a niche and the concept of total return was somewhat lost in the shuffle of a go-go growth cycle. Meanwhile, a major bond bull market brought interest rates (and thus bond yield) down, too.
For the past several years, interest rates have continued to decline ultimately reaching current near-record lows. This gets interesting when you begin compare the yield of government bonds – a 10 year US Treasury yielded 1.92% as of 9/30/2011 – to the dividend yield of the S&P 500, 2.3% at the same time. The chart below goes further to analyze this phenomenon across countries.
Source: JPMorgan Asset Managment, FactSet, MSCI.
Research from Bespoke Investments as shown in our next chart indicates that the 10-year Treasury yields are currently around 2% as of 9/14/11. They go on to note that 46% of stocks in the S&P 500 pay a higher dividend than this bond yield. In times of uncertainty, it is fair to point out that the relative safety of Treasury yields may not be a fair comparison. Risk assessment is always critical in analyzing investment decisions.
Source: Bespoke Investments
No investment theme bats 100% and a dividend-focused stock strategy requires time and risk tolerance that must be carefully considered. Today’s investment landscape is unique. I can see why a dividend-focused investment theme is worth a second look.
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