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Stingy Investor Tip Sheet

The Downside of Dividends

Stocks with big dividends have a reputation for holding up well during downturns. But many dividend stocks have been decimated during the recent sell off.

Before looking at the recent results, let's take a quick look at past returns. James O'Shaughnessy in his fine book "What Works on Wall Street" (3rd edition) reported that between 1951 and 2003, the top 50 yielding stocks in his large-stock universe gained 13.6% on average annually. That's better than the large-stock average annual return of 11.7%. Even better, the maximum peak-to-trough decline was -29.0% for the dividend portfolio versus -46.6% for the average large-cap stock portfolio. Overall, large high-yielding stocks have provided better returns over time and they've fallen less in bad times. That's a big win-win.

Similar results have been reported by several other authors and these good characteristics led to the creation of many dividend funds. Problem is, these funds (and the strategy more generally) is starting to set new records on the downside.

For instance, the RBC O'Shaughnessy U.S. Value fund (which follows a variant of the high yield, large cap approach) has fallen 42.1% so far this year. It's peak-to-trough decline is in excess of 50%. The iShares Dow Jones Select Dividend Index (DVY) sports a peak-to-trough decline of 47.8%. The S&P500's recent peak-to-trough decline is 46.7%, not including dividends. As a result, dividend investors have suffered larger than market declines up to this point in the current downturn.

It could be that the index is due for an even bigger dubbing and that dividend stocks will hold up better. We won't know until we're through the entire cycle.

But, at the moment, we now have a rather ugly data point for dividend investors. It would appear that high-yield investing may not cushion one against bear markets quite as well as we might have previously hoped.

We don't think that it's time to give up on high-yield investing but the 2008 crash hurt dividend investors more than expected.

10/29/2008   4:50 PM EST   Permlink   save & shareDividends

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