Sunday, January 6, 2013

Dividend Growing Blue Chip Stocks are the 'New' Bonds ... And They'll Be Better Assets to Own Than Bonds the Next Ten Years

For the next decade or two, expect dividends from blue chip companies to outpace returns on bonds.

In addition to higher cash payments and lower taxes on dividends than interest on bonds, there is an excellent chance for substantial inflation adjusted share price appreciation as well.

Bonds, on the other hand, will decline in value over time as interest rates rise. The math for bonds is simple. Bond prices go down as interest rates go up.

Habits are hard to break, of course, but substituting strong stocks for bonds and other fixed rate investments is a great bet going forward and clearly the prudent thing to do for individuals and institutions as well. At least that's my view.

Hoping for a 2013 'dividend revolution' has the summary:

"The last two months have been a mini-Golden Age for the “special dividend,” as companies, anticipating that tax rates on dividends will shoot upwards on Jan. 1 as part of the fiscal-cliff fiasco, have accelerated payments that were originally scheduled for January. But as the Wall Street Journal’s Jason Zweig points out in a column this week, 2012 was also a record-breaking year for regular dividends, even before the fiscal-cliff panic. Companies in the Standard & Poor’s 500-stock index will have paid out $281 billion in regular dividends by the end of the year—17% more than in 2011, and 13% more than in 2008, the previous high-water mark.
Zweig expresses hope that these rising payouts are harbingers of “a long-term change in the way companies treat cash and their outside shareholders”—a change that could be encouraging for retirees and other investors who need to rely on their portfolios for an income. A 12-year-span marked by two disastrous bear markets has broken investors’ faith that they can rely on stocks for low-risk growth; to keep investors on board, Zweig argues, more companies will need to pay higher dividends to compensate them for the perceived dangers of owning stocks.

The result could be something of a Chester A. Arthur stock market – one where most of the returns from the stock market come from dividend income, as was the case for U.S. stocks in the 19th century. And it would give older investors an intriguing option: They could think of the stock allocation in their portfolio as another income source, one that might occasionally give them a boost in the form of price appreciation as well. (Of course, there’s one big caveat: Dividend payouts aren’t guaranteed and can get slashed when a company’s earnings get squeezed, as investors found out in 2009, when S&P 500 dividends dove by about 20%.)"

Summing Up

Here's the straightforward two part future case for preferring stocks over bonds in a nutshell.

#1 - Cash dividends on stocks will tend to grow over time, and their yields are already higher than yields on current bonds owned and outstanding.

#2 - Share prices on those stocks will tend to increase over time and the value of bonds will decrease in the next decade's investing environment of rising interest rates.

So if a stock's cash yields 3% today and grows at an annual rate of 7% the next 10 years, the yield on cost would  then be 6%.

Then even assuming a "worst case" dividend cut of 20%,  which I very much don't expect to happen,  using the rule of 72 the stock would still yield 4.8% on initial cost.

High quality bonds yield less than 3% and nowhere close to 4.8% or 6% today.

And the principal value on bonds won't be increasing as interest rates will almost certainly be higher than they are now in 10 years.

Accordingly, individuals would be well advised to consider substituting dividend paying blue chip stocks for bonds.

It's a good investing habit for individual investors to develop for the foreseeable future.

Thanks. Bob.

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