Your Investments: Stock dividend yields versus bond yields

Stock-market investing is risky, and someone living on tight fixed income should stick to low-yielding bonds instead of putting principal at risk.

By AARON KATSMAN
November 25, 2010 00:00
3 minute read.
Aaron Katsman

Aaron Katsman 58. (photo credit: Courtesy)

 
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With global financial markets continuing their volatile ways, many investors have thrown in the towel regarding investing in stocks and have moved all their money into bonds.

A recent Reuters article highlighting this trend reported: “ICI estimates $19 billion has left mutual funds for the year so far as of the end of August. In September, equity funds recorded their fifth consecutive month of outflows. For the most part, investors are eschewing stocks for the perceived safety of bonds and other fixed-income assets, trading the possibility of high returns for stability. Bond funds took in an unprecedented $376 billion in 2009 and another estimated $216 billion in 2010 as of the end of August.”

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Due to this huge influx of cash being used to buy bonds, bond prices have skyrocketed, meaning that yields on traditional income-producing investments such as investmentgrade bonds and deposits are paying next to nothing (inverse relationship between bond prices and yields).

Refuge in bonds With rates at record-low levels, corporations have sprung into action issuing long-term bonds at ridiculously low interest rates. It has gotten to the point that in many cases, a company’s stock dividend is much higher that the bond yield of the same issue.

According to J. Alex Tarquino of SmartMoney Magazine: “Since the crash, of course, investors have sought refuge in bonds of all kinds.

Taking advantage of that demand, the corporate finance types at some of America’s best-known companies have sprung into action. McDonald’s recently sold 10-year bonds at 3.5 percent – a new low for a 10-year investment-grade bond. Shortly after that, health giant Johnson & Johnson (keep in mind that JNJ has boosted its dividend for 48 straight years) sold 10-year bonds at 2.95 percent – well below the 3.4 percent dividend yield on J&J stock. As Microsoft sold 10-year bonds at 3.1 percent, it also boosted its stock dividend, bringing the dividend yield to 2.4 percent.

“The lesson for investors, say some strategists, is to bypass bonds and take a close look at the stocks of dividend- paying blue-chip companies.



Why settle for 1 percent on a threeyear IBM bond when its stock pays a 1.8 percent dividend and the company has increased its quarterly payout for 15 consecutive years?” In this interest-rate environment, one should take a long look at dividend- paying stocks as a way to help lower market volatility and generate income.

What are dividends? Dividends are the share of a company’s profits that it decides to pay to its shareholders. They are an important part of the total return achieved from investing in stock, in addition to any increase in the share price. While your principal is at risk if the stock drops, many analysts forecast that the table is set for dividend stocks to perform well. They point to relatively high dividend yields and that they believe the stock market is cheap.

According to the highly regarded Bespoke Investment Group: “Priceto- earnings ratios, a measure of a stock’s value, remain depressed today. S&P 500 companies are now trading at about 12.3 times estimated 2011 earnings, according to Thomson Reuters data. Since 1960 the price-to-earnings ratio has been about 16.4, which suggests that stocks today are a relative steal.”

Not for everyone It’s important to emphasize that fixed-income investors who try to enhance the income generated in their portfolio solely through investing in dividend-paying stocks are doing so at their own peril. The chance that the stock bought drops substantially surely exists.

Stock-market investing is risky, and someone living on tight fixed income should stick to low-yielding bonds instead of putting principal at risk.

But for investors who have some wiggle room regarding the income they need to generate to meet their lifestyle, or are looking for an alternative to a highly volatile portfolio, dividend- paying stocks in this current environment are awfully attractive.

aaron@lighthousecapital.co.il

Aaron Katsman is a licensed financial adviser in Israel and the United States who helps people open investment accounts in the US.

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