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Guest Post: Dividends Are Still Trending Worse Than The Great Depression
Submitted by Thought Offerings
With S&P 500 earnings reporting mostly (98%) complete for Q3 2009, it's time for an update to the charts from Dividends, Earnings, and Stock Price Trends have Tracked the Great Depression.
The
following chart compares the decline in twelve month trailing earnings
and dividends since the stock market peaked in October 2007 to the same
measures following the stock market peak in September 1929:
Earnings have dropped more rapidly than during the Great Depression (dramatically so if you count reported rather than operating earnings), but they appear to have begun a recovery much sooner than occurred back then. Trailing 12-month dividends are still falling slightly faster than during the Great Depression, which is particularly remarkable given how much more severe deflation was then compared to now. These trends underscore that contrary to some claims, this is no crisis of confidence!
Since
dividend changes tend to lag earnings changes, rising earnings could
mean dividends will level out and start increasing soon (and in fact
the quarterly fall in dividends from Q2 to Q3 was small). However, if
earnings are being over-reported thanks to factors such as relaxed
accounting rules or optimistic loan loss assumptions, dividends should ultimately reveal the truth about underlying cash flows.
And
while we should all hope that this recovery can be sustained, there is
a significant probability (details of which I hope to discuss in a
separate post) that this is a temporary upturn in a longer term depression. A renewed fall in GDP, persistent unemployment, and intensifying deflationary pressures would not be good news for any fledgling recovery in earnings and dividends.
Here
is a chart comparing the dividend yield today with the Great Depression
trend. Yields are much lower today and are trending down again despite
the significant upward yield trend back then. So is this a genuine
early economic recovery, or a sign that the modern stock market tends
to be a capital-gain seeking momentum machine with little regard for
underlying fundamentals? Yes, interest rates are low, but they were
back then too, and David Rosenberg suggests most current corporate bond
yields are a lot more attractive than yields of the same companies'
stocks.
The next chart compares price/earnings ratios earnings during the Great
Depression with today using reported earnings. There is no comparison.
It is clear that the market has accepted Wall Street's encouragement to ignore reported earnings when valuing stocks,
so here is the same price/earnings chart using operating earnings (for
the recent trend — the measure had not been invented back then):
The P/E ratio based on operating earnings has soared above 25 just as
it did at a later stage during the Great Depression. I just wish I had
more confidence that this was the start of an earlier sustainable
recovery rather than a sign of the irrationality of markets and reckless myopia.
Note:
All of these charts use Robert Shiller's monthly stock data (with a
single representative stock price for each month), not daily prices.
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Excellent article. Companies may have less
free cash flow because they are more leveraged
than in 1929 and have to use their cash to
service debt. Does your dividend data include
the amounts paid to preferred stocks or is it
just to common shares? I wonder if there are
more preferreds this time around than in 1929.
Excellent question on the preferreds. I am also interested in the answer. I have given up on the P/E multiple as having any indicative importance; however, the dividend yield is interesting because it compensates for the fraudulent operating earnings. Any steepening (upswing) in the dividend yield would signal that companies are making enough excess money to distribute it to investors. I don't think that will happen anytime soon, but it is a good metric to gauge the extent of any recovery.
Good question, but I don't know. The data is from the earnings spreadsheet on standardandpoors.com (first link in the post). For Q3 cash dividends per share were $5.35.
- ThoughtOfferings
I doubt this is the case because it is my understanding that in 29 50% of all debt was corporate. Admittedly this may have been skewed, perhaps strongly, by the late stage of the investment trusts which may be included in the corporate calcuations.
Maybe non financial corporations were not highly leveraged in 29. On the other hand I have no way of knowing but I would be shocked if in 29 the share of all cash flows and earnings of corporations were not a far lesser part of the whole of cash flow and earnings. If you get my drift.
Maybe it's time for the Kerry trade--long HNZ, short SPY.
I have been saying for some time (sharing Rosenberg's view) that the pathetic dividend yield on the S&P 500 is a clear indication of earnings quality (the lack thereof).
The earnings are either not real (the result of accounting fraud and/or regulatory "forebearance") or not sustainable.
The fact that "investors" do not DEMAND higher dividend payouts is yet another troubling sign. "Investors" have embraced the notion that the equity market is a short-term capital gain-seeking exercise and not a thing more.
Despite three burst bubbles in less than ten years, the idea that we can all become "rich" by owning over-valued assets is alive and well.
Could it be that the earnings are (fairly) real and that the firms are just putting the "missing dividend" into deleveraging?
Or executive compensation?
I doubt non-financial exec. comp. is up this year compared to 2007, but what do I know? Either way, it's a different story than exaggerated profits, and it would be nice to know which is really happening.
So the markets of today value capital gains more highly than dividends, is that news?
Some people just don't get it. Stocks have always been priced on future expected earnings rather than current reported earnings as far back as i can remember. It's only when expected earnings become unrealistic that you know a bubble has formed.
Also, business practices have changed dramatically since 1929. Management which generally came from outside 'the family' are much less tied-in to the businesses they run, thus more detached from the interests of their shareholders. Dividend payouts cut into operating capital - which can be reinvested into the business for larger profits (or ill-conceived expansions/acquisitions). Good or bad, that really depends on the talent/integrity of the specific management team in question.
Agreed on pricing for future expectations, and interesting point regarding 1929. However, the main focus in the post wasn't the lower dividend yield today, but rather how much dividends have declined in relative terms since the market peaked. Growth in dividends (or share buybacks) should eventually be needed to validate these expectation-based capital gains. It may happen on the heels of the current apparent earnings recovery, but we had such a huge earnings bubble relative to history that a return to anything approaching that level was arguably not the most rational thing for the market to price in.
- ThoughtOfferings
i'd just like to make a quick correction on my first point point: there still are stocks in demand for steady dividend
payouts. These are typically the low-growth utility and infrastructure stocks. Good if you're planning for retirement.
Let's not forget that the financial services sector represents a much greater share of the SPX's earnings now than during the Great Depression (the one in the 20s and 30s, not this one). Let's not forget that financial's earnings now are powered by faulty, mark to menagerie accounting; i follow the bank analysts and very few seem to recall that FASB 157 has been amended to the detriment of accurate financial reporting.
It would be interesting to know if asset marking adjustments were made to financial firm balance sheets during the First Depression. I seem to recall there was an M2M emergency suspension in the early 90s.
I've been curious about this issue for 9 months. It seems the abnormal.....mark-to-myth... has quickly become the normal for financial analysts. They must believe it will go on indefinetely ( until the roof caves in, I mean ).
DH, you have been on fire the last couple of days!!
As for bank analysts well their purpose is to support capital markets activity. That necessitates a suspension of fact.
"....you know what is good about the truth, everyone knows what it is, how ever long they have lived without it. no one forgets the truth, they just get better at lying.."
i tend to notice that most of the analysts pushing the banks are on the sell side....big surprise, eh? then again, the club has to support each other at this point or else they all die.
I think UBS is the only one on a macro level that has negatives on the banks.
A very interesting tell for me is Bianco at BAC/ML....his team has financials as "overweight" but there are three specific issues that I keep my eye on: ML has a "sell" on AXP and COF and they simply will not rate WFC. As of last week, it is still on "extended review".
I still say if the Fed, FDIC, Treasury can't keep the lid on the near insolvent banking system, WFC is my candidate for the shit hitting the fan.
What year was it that the Capital gains tax was changed? What was the capital gains tax rates during the GD. Never underestimate the impact that tax rates have on the capital-gain seeking robots.
Overleverage - check
Over production - check
Over concentration (in asset categories) - check
American-style corporate capitalism is DEAD.
Somebody please inter the corpse. its starting to stink.
http://www.mebanefaber.com/2007/02/21/a-better-dog/
Dividends are only one way of returning capital to shareholders. Share repurchases are another such method (see MSFT), and since they are not taxed like dividends, it can be argued they are a more efficient way of returning profits. Buybacks represent about half of all shareholder payouts, and have increased steadily since the early 1980’s. There is a structural reason for this, and is due primarily to the SEC instituting rule 10b-18 in 1982 – providing a safe harbor for firms conducting repurchases from stock manipulation charges. See Grullon and Michaely [2002] for more info on the impact of Rule 10b-18.
The authors examined the payout yield and net payout yield, whose formula is:
Payout Yield = $ spent on dividends + $ spent on share repurchases
(Net payout is simply subtracting the $ raised through new share issues to the above formula)
The authors find that “the widely documented decline in the predictive power of dividends for excess stock returns is due largely to the omission of alternative channels by which firms distribute and receive cash from shareholdlers.” Additionally, while dividend yield has lost its predictive ability over time, the payout yield has remained a robust indicator for excess stock return.
From 1983 – 2003 the various strategies returned:
Dow: 13.4%
DOGS: 16.2%
NPY: 19.1%
Most share repurchase programs stink. A big portion of share repurchases are simply to offset the dilution from stock option issuance, yet you'll hear managements that do that talk about "returning money to shareholders". In reality they don't want to return money to shareholders because if they pay out $100 million in dividends it makes the company $100 million less valuable on the payout and that harms the value of their stock options.
Many managements don't even try to buy back their stock when it's cheap, they buy based on when they have excess cash flow, which is generally when business is good and their stock prices are high. Companies that were buying back their own stock hand over fist at high prices in 2007 quit buying back their stock in 2008-09 when their stock prices had collapsed. Many that had bought their shares high issued new shares at a fraction of the prices they had paid to repurchase shares.
Share repurchases are generally a shareholder ripoff. With relatively rare exceptions for managements that have a good history of capital allocation, shareholders should demand money spent on share buybacks be shifted to cash dividends.
dividends should ultimately reveal the truth about underlying cash flows.
maybe, but you have hedge funds like GoniffSachs that pays out $21 Billion in bonuses and only $700 million in dividends, and the shareholders are getting nowhere with their 'protests'.
CW,
as long as the shareholders protest nothing is going to happen.
Once they sell in droves that might change.
Yeah but why should they have to sell, they own the company. Management and the Board are supposed to work for the shareholders.
And they should elect a new Board then. But they don't. They are all intertwined. CEO A serves on CEO B's corporate board. The system is not so clean as they pitch in college and finance books.
No they don't own the company, although they think they do. Board is supposed to represent their interests, well, how did that work out? And by the by, why are board membership periods staggered, and who nominates for the board?
Financials are just not worth owning, except for intraday trades.
Somewhat skeptical of the practicality of the comparison. Now we have far more tech companies that don't pay dividends, and similar attitude has progressed into dividend paying companies as well, resulting in smaller increases in dividends.
>>>Now we have far more tech companies that don't pay dividends,
OK, but the post is discussing the change in dividend payouts, not the absolute level. You're probably right that dividend growth has slowed by historical standards, but that still doesn't explain the sharp continuing plunge in dividends..
Since when does fundamental value matter anymore? Get ready for some recasting to occur with the Option ARMs out there :)
Fundamental joke
Valuation illusion
Systemic FUBAR
The entire stock market has nothing to do with the public, but instead is a bunch of poker chips used by machines for relative valuation. The public is used for liquidity to allow for the passing of the bag and nothing else. Hedge funds pair trade stocks. this means only that they decide that one stock is going up less than another or down less than another and not necessarily that either are going to increase in price. The price of stock is set by the market makers, moved by the market makers and dumped on an unsuspecting public. If the market makers get into trouble, the SEC changes the rules to allow the house to take control of the casino once more. The wildcard is the corporate raider game, which hopefully ends in life time prison sentances for current billionaires who have stolen repeatedly with the aid of the government, Wall Street and the banks. I am amazed this scheme has held up over about 18 months and we are now in the 15th straight year of a bubble in stock prices, even while in a depression.
Maybe we are talking the lack of leverage, but this kind of scheme has been tried in real estate over and over again and once the list of bigger fools runs out and the prices drop, the game has to be liquidated down to some point. There isn't a person that knows finance that isn't brain damaged that would own the SPX and most likely 99% of the stocks on the exchange. A 2% dividend indicates a 25 PE at best, figuring 50% of earnings are actually paid out and anything better than that is created out of fraud and little else. One could make a case that stock buybacks were part of dividends, but I believe them to be a management compensation scheme and little else. Plus, if they had been surplus dividends, then it wouldn't have been necessary to cut dividends as they have been cut. The big repurchase games I recall were Citi, BAC, XOM (which was generating more cash than it could reinvest in its industry), MSFT(Gates, Allen and Balmour (sp) sell billions of stock a year combined and need someone to buy it) and a few others.
Here is where the bulls are cornered and they may not know it. Inflation, in the form of true inflation, the financing of sales, created the profits of most companies. A company might be able to run in place without true credit expansion, but you could forget growth. Risk free returns are 3% over inflation. Stock returns are supposed to be 6%. We have 2% in dividends. History has been earnings grow 1% or less over inflation, but this history has been during an inflationary trend, meaning healthy credit expansion. Optimism is a key compoent in that formula and if the trend turns to real earnings declining, which I believe is going to be the case, then the price of the market has to turn to a dividend to support that formula. Thus we could easily see dividends cut and the dividend yield go to 8% or 10% too. Then the psychology on stocks will turn. It will be time to buy, but most people will have already lost their money and will either be broke or needing to sell at the bottom. This is going to be a real train wreck.
P on the E--a real problem--