Wednesday, June 01, 2011

"How, Oh How, Is the Economy Not Recovering?"

I love stories like this where the "professionals of Wall Street" (remember those guys, the ones that headed up elite investment banks like Bear Stearns and Lehman Brothers) are "shocked, shocked" the economy hasn't recovered yet. What I love more is when they put the cart before the horse, driving up stock prices FIRST, presuming economic growth will follow. And then, perhaps the greatest quote in the entire article is:

"With these kind of dividend yields, these stocks are a steal!"

So once again it seems high time to me to explain the "dividend yield" and provide an important lesson in this fascinating ratio.

The dividend yield is the dividends of a stock divided by the price of a stock. In short it shows you the percent return you can expect to receive from dividends. So for example if a stock pays a $1 dividend per share and it's currently trading at $10, your dividend yield is 10%.

Most people scoff at dividends because they invest in stocks "because they will hopefully go up in the future." This increase in the stock price is called a capital gain. And while they provide the basis for millions of people's retirements and trillions of invested dollars, the premise of investing in a stock "because it will go up in the future" is flawed and will cause a horrendous problem in the future.

Understand what drives the price of a stock is the earnings or profits the firm makes.

HOWEVER,

you as a shareholder will not see the earnings of the firm. You only get to see the portion of the earnings the firm decides to pay out as it may wish to retain some of those earnings and reinvest them back into the company. This portion they pay out is the dividend.

Now, if you think about it, you will realize that the ONLY thing that really drives the price or value of a stock is the dividends because that is ALL the shareholders see.

Of course some people will say, "Yes, but don't I get SOME money in the future if I sell it?"

Correct, but when you sell it in the future, why did somebody pay you money for your shares? Or a better question, "what did you sell to that person?"

You didn't sell him "something you can sell for more in the future." You sold him a share of stock that will entitle him to the future dividends that stock will pay. That is what gives the stock value. The stock could be sold over and over again, but you are inevitably selling a security that pays out dividends and nothing else.

So are dividends so high and prices so low that they are "a steal" as super intelligent Wall Street investment types say they are?

Well, here you go.



I've pointed this out before, but I shall say it again.

Dividends historically paid out around 5%. Today they are below 2%.

The reason why dividend yields are so low can be explained by reading the post about 3 posts below titled "When You Abandon Fundamental Value."

So my fine loyal readers, take it from the Captain. Right now buying the average S&P 500 stock is like buying something at about 2.5X's more expensive than it traditionally has been. To put it into perspective think of common everyday consumables we buy with the following prices;

A gallon of gas going for $9.75
A Kia Rio going for $25,000
A Big Mac going for $8.75
A movie ticket for $25

That is what (using the dividend yield as a metric for value) buying into the US stock market is like today.

And bar any economic growth (which there is "surprisingly little" of), you can expect reality and efficiency to hit the markets. May not happen today. May not happen tomorrow. But it will happen. And the only thing that is going to give your precious little 401k balances a boost is going to be BOOMING economic growth that can only come from a Austrian economic model ala Ronald Reagan circa 1981 and not this Keynesian nightmare the naivety of the American voting public has wreaked upon us.

15 comments:

  1. Jules2:59 PM

    I'm a business major and this one post makes more sense than any class I've taken. Context matters.

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  2. Well Jules you should take my superawesome class on stock valuation and analysis. At minimum it will make accounting a breeze;

    www.ed2go.com/courses/10f

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  3. Anonymous7:04 PM

    It is obvious that a lot of money managers are clueless about politics. Most of them know (presumably) a lot about various financial instruments, and that will work much of the time, but in times such as these a knowledge of history and politics and, as you demonstrate, of economics, is essential.

    As for the money managers, Nessim Taleb has emphasised how often they blow up and take their firms with them.

    The only substantial money I ever made (and it was less than half a million) in stocks was when I was involved in a small IPO.

    I suppose that shareholders in a company that is subject to a takeover might sometimes do well.

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  4. Anonymous5:49 AM

    I agree with you for the most part. I only quibble a little about the locig you use for how stocks are bought. Most stocks today are not bought by individuals either speculating (betting on the bubble) or looking for dividends. They are bought by fund managers who must find something to buy every singekl week because of automatic 401K contributions. So it is a race of constantly looking for the stock that isn't the most overpriced just to fill up the portfolio. They accept that they can handle a few dogs is the bulk of the fund is healthy.

    Most people in the stock market are in using their retirement funds and have no clue about which stocks are being bought with their money.

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  5. Anonymous6:39 AM

    Really off-topic, but where do you buy Kia Rio for 25k USD? It is a bit much (15k would be appropriate). Or do you have some special taxes (like in Denmark) I do not know about?
    Anyway, the article is good.

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  6. Anonymous6:41 AM

    Oooops, my fault, I should read the article properly. (The Kia Rio comment)

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  7. Anonymous7:39 AM

    Captain, are you an MGTOW? have you left the market? I read the archived posts about the topic. are allot of guys?

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  8. Anonymous8:10 AM

    Dividends are also subject to double taxation. This has distorted the value of dividends.

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  9. Anonymous8:15 AM

    http://www.marketwatch.com/story/next-stop-dow-20000-2011-06-02

    Dow 20000!

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  10. BudFox8:33 AM

    Great post. People miss this about valuations. The wildcard is hyper inflation. Companies own things and brands and can raise prices if the dollar collapses. The government is devaluing our savings forcing us to do something with the money. If the dollar loses 75 percent of its puchasing power, the market should go up. Maybe not 4 times to compensate but maybe 2 or three times. If rates then rise to save the dollar it gets ugly fast.

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  11. Anonymous11:54 AM

    This is the problem with how the ivy league nomenklatura have been trained since ww2.

    To these people the numbers on the ledgers and spreadsheets are more real than the actual products and services those numbers are supposed to represent. So they fiddle with the spreadsheets and figure the problem is now solved.

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  12. sth_txs7:42 PM

    Well, when a president says he wants to slap around oil companies and seize your retirement funds to prop up government debt, that makes me feel optimistic.

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  13. sth_txs9:26 PM

    A few comments on Reagan:
    http://www.lewrockwell.com/rothbard/rothbard60.html

    http://mises.org/daily/5009/The-Reagan-Fraud-and-After

    He talked a good line.

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  14. Anonymous6:13 AM

    Most wall street "experts" are stock technicians playing a game according to the arcane rules of the trade. SMart, but limited.

    Very few lift their heads from the feeding bowls long enough to look around and think.

    Of course then they are quote by "journalists" who are as a general rule somewhat ignorant of the topic they cover and they mangle what information they got beyond recognition.

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  15. On interesting point: the most recent peak in dividend yield was at the end of the Carter era. I wonder how much of that has to do with the increasing tax preference for capital gains.

    The fact the dividends are taxed twice (once as corporate profits and once as personal income) combined with the fact that when taxed capital gains are taxed at as little as one third the rate (Bush era reforms that were extended do change this some, but not 100%) seems like it could be affecting the price but you'd expect it to go the other way.

    What's really troublesome is the gov't effort to eliminate dividends is what made Enrol et al possible. When you're cooking the books to drive up prices the fact they're cooked can be hidden a long time. When you're cooking the books when dividends are what everyone is watching it'll catch up with you the first quarter you can't convert profits into a check to shareholders.

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