James Montier Loves Dividends

Barry Ritholtz posted a commentary from James Montier about dividends that is a useful read and has some handy data. To a large extent I am a big fan of dividends but there are limits to what they can provide. If you think in terms of the S&P 500 having yielded close to 2% for quite a while now (it yielded much more in decades past), a portfolio that yields the same 2% is relying on price appreciation for a lot of the return. The more a portfolio relies on price appreciation the more the person running the portfolio has to be correct about selecting countries, sectors, stocks, themes and so on. The higher the yield the less reliance the portfolio has on the manager being right.

At the same time though a portfolio full of 4-5 percenters is probably not going to be a very well diversified portfolio. In most years this won't matter but in a year like 2003 or 2009 a dividend centric portfolio will likely lag. In 2009 the SPX was up 29%, SDY was up 20% and DVY was up 11%. In 2008 DVY did a tad worse than the S&P 500 but SDY did quite a bit better. From the peak in October 2007 to what is hopefully the low in March 2009 the SPX dropped 56%, SDY 55% and DVY 62%. The reason to mention DVY and SDY is that they use different methodologies.

In terms of what dividends cannot do for you, a portfolio of great dividend payers that go down 40% in a down 56% world paying 4% is a poor substitute for the top down decision to reduce, not eliminate, equity exposure in the face of an unhealthy market (for anyone new we take defensive action when the S&P 500 goes below its 200 DMA).

Top down in its simplest form calls for getting out of the market when conditions favor the downside with the idea being it is unlikely that an investor can find the few stocks that will go up during a 50% decline and relevant to this conversation a 4% dividend does not provide much solace.

However in a market that is down a little like maybe 5-10% the shelter offered by dividends becomes much more compelling. Again though too much exposure to fat, albeit healthy, yields increases the likelihood of getting left behind during a great up year and there are few enough of those that getting left behind in 2003 is a very bad idea when you consider that in most bull cycles a disproportionately large amount of the cycle's up move comes in only one year.

IMO a properly diversified portfolio owns all different types of stocks including some high yielders and some zero yielders (and others in between). If a diversified portfolio includes several 4-5 percenters and maybe one MLP (or the like) and then a few that are close to the market's 2% then the portfolio has a good chance of having the overall yield coming in at 3% and while that may not sound like much more than the market, 100 basis points of "extra" yield puts less pressure, as mentioned above, on the rest of the portfolio but should do a better job going along for the ride when the market is up a lot, assuming it is reasonably well constructed.

Dividends are also one of the benefits of foreign investing. Many markets typically have larger dividends than the US market. For example iShares Singapore (EWS) yields 3.05%, client and personal holding iShares Australia (EWA) yields 3.79% and iShares Brazil (EWZ) yields 3.66%. I would note those are trailing yields and future payouts might be much different.

Another positive for dividends is the accumulation over long periods of time. As noted EWA yields 3.79%. Most clients own Australia and New Zealand Bank (ANZBY) for exposure to the country, I first bought it in September 2003 and have held it ever since. Throughout most of that time as the stock has had its ups and downs it has yielded 5% except when the market was panicking down when the yield was in the neighborhood of 10%.

For purposes of this post I did not look up the exact date of purchase nor do I have the exact price but on Sept 15 2003 the ADR closed at a split adjusted $12.10. Since I've owned it has done fabulously well at some points, went down a lot during the panic, went up a lot during the snapback all of which leaves the original purchase up $7.56 as of yesterday's close which works out to a 62% price appreciation versus a 1.8% gain for the S&P 500 (SPX closed at 1036 on September 15 2003). While I think that is good, clients who bought back then have also collected $6.92 in dividends making the total gain $14.48 or 119%.

While that was a warm story about a boy and his dividends it is just one example there are countless others and this sort of thing is part of the argument that the dividend-only crowd relies on but it is still no substitute in my opinion for defensive action in the face of a troubled market. While this may seem contradictory I believe it is more of an all things in moderation approach. I mentioned top down in its simplest would have someone completely out of the market but that is not practical for several reasons. This has been a name that I bought with the hope holding forever and so far so good.

Over that long period of time I believe the result in the one bank stock combined with other top down things done have helped with the long term result. However just as important has been another foreign stock held almost as long that I have mentioned many times before that is up about 700% going back to September 2003 (up a little over 200% since I bought in 2005) but is not much of a dividend payer. Again there are countless others that have done something similar. I would expect any well diversified portfolio to have a couple like the dividend paying bank and the other foreign stock that is up a lot.

From the standpoint of investing for the entire cycle, or with the idea of giving yourself the best chance possible of having enough money when you need it, it makes sense (repeated for emphasis) to own different types of stocks with with different attributes.