Stock Values and Dividend Yields are HIGHLY Correlated

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I did a lot of investing videos this week. Here are a couple: Understanding bonds. and Stock Dividends. There are plenty more where those came from actually. Here’s my entire Investing playlist (135 videos and counting on investing concepts. Watch ’em all!)

I want to point out a couple things in this email about investing though. I hear ALL the time about the Dividend Yield of various stocks as if that means something special. It does not and I’ll explain in a second.

I also here a lot about the “Value Tilt” in investing, i.e., value stocks outperform as if that’s an investing anomaly. It is not and I will explain that too.

But first, if you are interested in investing concepts I’ll share with you three books you really need to have in your library.

The first, of course, is Jeremy Siegal’s Stocks For The Long Run. I’ve spoken about this before and I’ll speak of it many times in the future. It’s the Bible for investing. Every investor needs to have this in his/her library.

Number two will be John Bogle’s Common Sense on Mutual Funds. A friend made me aware of Bogles last book before he died called The Little Book Of Common Sense Investing which I haven’t read yet, but certainly will.

The third book is written by a guy I’m sure you’ve never heard of Ed Easterling at Crestmont Research. This book is called “Probably Outcomes”. I can not recommend this book enough. I read this book while vacationing with my family in Phoenix, AZ over Easter break back in 2012. I sat poolside, with highlighter in hand, watching the kids to make sure they didn’t drown but engrossed in Ed’s book. Simply fascinating look at investing that a lot of people, shoot MOST people, overlook.

So, let’s start with dividend yield. Dividend yield is nothing more than the DIVIDEND the company pays divided by the CURRENT share price of the stock. Thus for a Dividend Yield to be high means the stock price must be low.

Think about it like this; the average dividend yield of the SP 500 right now is around 2.3%. If Company X has a dividend yield of 4.6% that means it’s twice that of the average stock on the S and P. The first question I’d ask is “Why is this the case?”

Well it may be it’s a highly regulated industry and the only real way it can reward investors is by paying dividends. Okay. But what if it’s NOT a highly regulated industry. Why would the yield be that much higher than the other constituents of the SP 500?

Let’s say the dividend is $2 a share and the stock price is $50. That is a dividend yield of 4%. Is that good? There simply is NO way to know this because what if yesterday the dividend yield was 2%. For the dividend yield to be 4% today, that means the stock price dropped from $100 to what it is now. Is there a reason for that to happen? (I guess one could make the argument that the company increased its dividend to $2 from $1 a share. But for that to happen the stock price would not have moved. AWFUL hard to imagine that. )

There probably are huge warning signs that the company can’t afford it’s $2 per share dividend and thus could cut it. So, now what was a $100 stock but is now $50 drops the dividend to $1. What is the yield currently?

2%, right back where we were. But now you’re down 50% in share price! Not a good trade off.

For risk-taking investors, they’d want to buy that $50 stock with a $2 dividend thinking they will be rewarded that the company could cut it’s dividend but won’t. And, in fact, if the company doesn’t actually cut the dividend, guess what happens to the share price??? It goes up!

Those investors, then, were well rewarded for the risk of investing in that stock when it seemed things were dicey.

And this leads to the second point of the “Value Tilt”; it’s RISKY! And that’s why you can expect to get higher than average returns. More risk = more returns. Not rocket science here, my friends. But people hear so much about the out-performance of value over growth that it’s easy to forget why that happens.

Value stocks have low Price to Earnings, high Dividend Yields, and low Price to Book ratio. Notice anything correlated there??? The PRICE IS LOW!

The minute the price is high all those things that make a value stock a value stock are lost and the stock is no longer considered “Value”. In the meantime though one doesn’t know if that value stock will emerge from its current sketchy state of affairs or not. Will it become like Apple in 1997 or Bethlehem Steel? Who knows?

But it’s risky. And thus the “Value Tilt” should reward those who are willing to take the risk. Ironically, it does. Weird, eh? More risk = More returns. Who knew?

What’s the lesson of this? Simple, the more you read from the legends and other not quite legends the more you realize investing just makes sense. it’s not gambling. Your retirement portfolio is not at the whim of high-frequency traders and algorithms. You don’t need to do anything fancy to succeed.

Just reduce your cost. Diversify your portfolio in index funds and be done with it except once or twice a year when it comes time to do some tax planning.

And if you follow these 3 things you will outperform the vast majority of your peers because they are trying to make the easy to understand complex, which is assuredly a losers game.

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