Wednesday, August 4, 2010

Buy and hold dividend investing is not dead

Many investors have been told that buy and hold does not work anymore. With almost everyone glued to screens streaming real-time quotes, news and charts and with so many institutional investors having extremely short term timeframes, one would certainly believe that buy and hold investing is a dinosaur strategy.

Over the past decade stock prices have been extremely volatile, which has led many to believe that short term trading is the answer. Even those who purchased shares in quality companies one decade ago such as Coca-Cola (KO) or Wal-Mart (WMT) didn’t perform better. The main reason for the low returns over the past decade was the fact that in the late 1990s investors forgot about fundamentals and bid up stock prices to unsustainable levels. The price/earnings ratio on the S&P 500 index increased to 30 times earnings, which was twice the average of the preceding eight decades. Thus investors were betting that earnings would keep increasing at a faster rate over the future.

The following stocks were overvalued in 2000. Yet these solid businesses still managed to grow earnings and distributions enough to make them attractive today:

For example Coca Cola (KO) ended at $60.94 in 2000. At that time the stock was trading at a price/earnings ratio of 69 and yielded 1.10%. Earnings per share increased almost 230% over the past decade, while dividends per share increased by 140%. Currently the stock trades at a price/earnings ratio of 18, while yielding 3.20%. (analysis)

Wal-Mart (WMT) ended at $53.13 in 2000. At that time the stock was trading at a price/earnings ratio of 44 and yielded 0.50%. Earnings per share increased almost 170% over the past decade, while dividends per share increased by 350%. Currently the stock trades at a price/earnings ratio of 13.50, while yielding 2.40%. (analysis)

McDonald's (MCD) ended at $34 in 2000. At that time the stock was trading at a price/earnings ratio of 23 and yielded 0.60%. Earnings per share increased almost 270% over the past decade, while dividends per share increased by 920%. Currently the stock trades at a price/earnings ratio of 16, while yielding 3.20%. (analysis)

Johnson & Johnson (JNJ) ended at $52.53 in 2000. At that time the stock was trading at a price/earnings ratio of 31 and yielded 1.20%. Earnings per share increased almost 170% over the past decade, while dividends per share increased by 210%. Currently the stock trades at a price/earnings ratio of 12, while yielding 3.70%. (analysis)

Automatic Data Processing (ADP) ended at $63.31 in 2000. At that time the stock was trading at a price/earnings ratio of 48 and yielded 0.65%. Earnings per share increased almost 100% over the past decade, while dividends per share increased by 280%. Currently the stock trades at a price/earnings ratio of 15.60, while yielding 3.30%. (analysis)

While stock prices were much overvalued at the beginning of the decade, some businesses managed to increase revenues and profits. The consistent increases in profitability have made many quality stocks that were overvalued in 2000 attractively valued. The only returns that buy and hold stock investors in those stocks generated came from dividends. This provided positive feedback to investors during two of the bear markets of the past decade. While yields were low due to the market being overvalued, quality companies kept raising dividends, which raised the yield on cost to original investors. If investors also managed to reinvest those dividends consistently, they would have been able to capitalize on any market weakness and further compound their dividend incomes in the process.

Despite the increasing noise in the markets, buy and hold investing does work. Investors who dismiss buy and hold investing altogether due to the poor performance over the past decade might be missing out on some great opportunities. Most of the quality dividend companies that were overvalued in 2000 are still quality businesses. Those businesses are attractively valued today, and yield much more than what they did in the year 2000. These businesses are also still growing, which means that investors should expect strong dividend growth in the future, which would increase their yield on cost. In addition to that, by reinvesting dividends, investors would be able to further compound their dividend income.

Full Disclosure: Long all stocks listed above

Relevant Articles:

- Dividend yield or dividend growth?
- 14 Dividend Stocks with Dividend Growth Potential
- Strong Brands Grow Dividends
- Benchmarking Dividend income

6 comments:

  1. Good analysis. I like the P/E ratio comparison...those were some high valuations back in 2000! It's hard to imagine things getting that rich again, but I'm sure it will happen someday.

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  2. It sounds like we have very similar strategies. It's funny when people think buying and holding is dead. They really don't understand how it all works. The net result of all traders will always be the market return. So they dance around, unproductively, while some win and others lose. But overall, the net average for all traders (before transaction costs) will be the net return of the market. After transaction costs and taxes, the majority of traders will lose to the buy and holders (ie, the market). Mathematically, that's how it works. Reading about a "traders market" reveals the ignorance of the writer. I hate to sound smug, but it always makes me smile when somebody pops off about something simple, that they don't understand.

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  3. "Long all stocks listed above" indeed. Nice post! I wonder if you can recycle the same article in another 10 years? :)

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  4. Very helpful analasis providing information I was not familiar with these statistics from 2000:

    P/E for Coke at 69
    Walmart at 44
    ADP at 48

    It is hardly suprising it has taken a full decade to return to reasonable prices - and in some cases, better than reasonable.

    As for dividend investing: it seems that now is the golden age.

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  5. Steven of ChicagoAugust 5, 2010 at 4:07 PM

    You don't make money when you buy stocks. You don't make money when you sell stocks. You make money when you hold stocks and let the companies make money for you.

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  6. I'd like to offer a different view.
    1. I am a dividend investor who does not employ a buy-and-hold strategy. My strategy is based on two things:
    a. I am sometimes wrong in my investment decision and there may be stocks or other investment vehicles that provide better income opportunities.
    b. Risk management. It recognizes that history is a one-time event. The factors that existed in the 80s-90s bull market do not exist today, and I don't know how today's economic conditions and the actions being taken to pull the nation out of recession will affect my portfolio. Was the 80s-90s bull market normal or was the 2000-2010 market normal? I don't know. I do know that my strategy has resulted in most of my stock positions being stopped out over the past 3 months (there are a few that are still open and continue to provide income). During this time I have continued to follow my strategy which means I have shifted to employing Bear Call spreads for income resulting in a 9% return on money-at-risk (which interestingly has exceeded the return on money-at-risk for my dividend stocks during the same period and during any 3-month period over the past year).
    c. Has my strategy hurt or helped my performance compared to a buy-and-hold strategy? It did as well as the buy-and-hold strategy prior to 2000 (during a bull market my strategy results in holding), and it exceeded the buy-and-hold strategy subsequent to 2000.
    2. I agree that the stocks identified in the post have exhibited fantastic growth in EPS and dividends. However, this list is data mining. It's one thing to say "these stocks would have been a great investment in 2000 based on their performance from 2000-2010". The question is, given the data available at the time, would you have invested in these stocks? I submit that there were many other stocks that looked good in 2000 that eventually cut dividends during the period because of the subsequent economic conditions. Ultimately your portfolio performance depends on cost basis and income which is determined by your entry point (and time).
    3. My final thoughts are that I do not believe the "stock market will always rise" is a valid assumption (especially during my investing horizon). I do not know which segment of the stock market's history was the "normal". I believe every investor ought to include risk management in their investing strategy, even buy-and-hold investors.

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