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Jeff Saut: Making a Case for the Bulls


Ten reasons to be optimistic.

I believe "income" will be a profitable investment theme for the foreseeable future. Indeed, the baby boomers are retiring; and, the yields afforded them via Treasury securities, money-market funds, and certificates of deposit (CDs) won't supplement their retirement account incomes enough to support them in the style to which they have become accustomed. Enter stocks, which since 1926 have averaged a total annualized return of 10.4%.

Interestingly, roughly 5% of that return has come from earnings growth, 0.9% has come from price-to-earnings (P/E) multiple expansions - but 4.5% of said return was derived from dividends. More than 40% of long-term investment returns have been driven by dividends. Furthermore, if investors buy non-dividend-paying stocks, and the overall stock market declines, they tend to be at the "directionality" of the stock market.

However, the shares that investors purchase of dividend-paying stocks, whose share price subsequently declines, actually own an asset that is becoming more valuable as its dividend yield rises, provided the dividend is maintained.

While some contend that aggregate corporate dividends have been reduced, and/or eliminated, due to the maelstrom in the financial complex, I have recommended avoiding financials for the last 5 years, and therefore have been relatively unaffected by those dividend reductions.

Excluding the battered financials, however, most corporate balance sheets appear in relatively good shape. Yet companies remain hesitant to commit more money to capital expenditures in this weakened economic environment. Therefore, I think it reasonable to expect corporations will use dividends as an increasingly valuable strategy for distributing excess cash.

To be sure, non-financial balance sheets are in better shape than the financial complexes', suggesting that dividends, and dividend increases, should be a favored corporate strategy going forward -- rather than share repurchases -- since for the last 18 months most share prices have traveled lower, making share repurchases a value-destroying strategy.

To this point, most companies have 2 avenues for cash: They can either plow back/re-invest in capital expenditures, M&A activities, and/or working capital initiatives, or they can pay/increase dividends, repurchase shares, and/or reduce debt. My analysis suggests that managers will probably pursue shareholder-friendly initiatives after meeting internal/external objectives. This implies they will likely pay, and/or increase, dividend streams.

This is a not unimportant observation, since the retiring "boomers" seem to be moving toward the mantra scribed in the first paragraph, of the first chapter, of Ben Graham's book The Intelligent Investor: "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

Note that Dr. Graham uses the word adequate, not spectacular, when speaking of investment returns. Plainly, secure dividends tend to cushion a portfolio and enhance total returns. Dividends also provide, at least to some degree, the "margin of safety" Ben Graham speaks of in the last chapter of his book: To wit, if you own a stock with a 7% yield, those shares can decline by 7% over the next 12 months, and you won't have lost any money.
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No positions in stocks mentioned.
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