With a dip of more than 11% in the S&P 500 since July 20 and continued volatility, what can advisors say to jittery clients?
For long term investors, nothing applies a calming salve better than a discussion about dividends.
Remember, during almost any 10-year period, approximately 40% of the total return from the SPY came from dividends.
Given this, a swoon in asset prices is concerning, but if dividends remain viable, there’s much, much less for investors to fret over. In fact, there are significant profits to be earned from dividends in a correction.
As a case in point, consider the recent performance of food maker Hershey. At the very bottom of the most recent downturn, August 26, HSY paid its quarterly dividend of about $0.60. Hershey investors who reinvest their dividends bought additional shares at $85.13 with their dividend proceeds. Just one week earlier, those same shares were $93.
So the August 25 dividend reinvestment offered investors a discount of 7.2% from prices just a week prior. Today, the shares purchased for $85 are now trading at $90 for a gain of 6% in just one week.
Even the most cursory analysis suggests buying additional shares at a 7% discount through dividend reinvestment is prudent speculation. The company sales weren’t down 7%. Nor were its earnings. Its gross and operating margins were about the same and people didn’t reduce their food consumption by 7% simply because the market was down by 11%.
But there’s so many more reasons why advisors can calm investors’ nerves by talking about the benefits and stability of dividends.
First, there is very strong resistance among corporate boards to reduce or eliminate dividends. It sends the wrong signals to investors and can permanently damage the stock. More importantly, there’s a very strong motivation to increase dividends because it attracts very stable, long-term investors.
As an example of these motivations in play, consider how John Deere (DE) shares behaved during the Great Recession. From a peak of $81 on May 1, 2008, DE shares bottomed out 10 months later at $38. Despite this, DE increased its dividend during this 10 month period by 10%. Today, the shares investors bought with reinvested dividends at $38 during the summer of 2008 are up about 160%.
Second, understanding whether or not a continued dividend payment is safe can be a relatively simple analysis. Basically, of all a corporation’s profits, what percent are paid as dividends? This is called the payout ratio. In the case of HSY it’s about 50%. This also means total profits at Hershey could fall by 50% before, numerically at least, the dividend is at risk.
Third, identifying companies likely to increase their dividends is a relatively simple analysis too: find stocks with a history of increasing their dividends where the payout ratio is 30% or less. Filter these results by strong balance sheets (remember, HSY profits may fall 50%, but the dividend could stay in tact if the balance sheet can support it), and you’ve got a cash generating machine that can easily outpace inflation during retirement.
In these volatile times, investors are on edge and they should be. However, for advisors, it’s a perfect time to meet with customers, review the portfolio by payout ratios , and develop the kind of long-term comfort that makes long term clients.
