President-elect Obama has promised to roll back the Bush tax breaks on dividends and capital gains. Many people have asked me if such a change in taxation would change our favorable view of companies with consistently rising dividends. The answer is no.
Many years ago I experienced a kind of eureka after an extensive look at 50 years of data for the Dow Jones Industrial Average (DJIA). I found that dividends and earnings were both highly correlated to price over this long expanse of time. But there was an important difference. Earnings had an annual standard deviation, think volatility, of nearly 23%, while dividends had a standard deviation of just over 8%. Indeed, I was surprised to find that DJIA earnings had a higher standard deviation than that of the Dow's price, which has been 14.5%.
Annual dividends have fallen very few times over the last 50 years, while earnings have fallen about every 4 years. In short, I found that using dividends in combination with interest rates could produce a very tight fit between a prediction of the year-end price of the Dow and what actually happened.
In our investment strategy, dividends represent not only a cash payment to us, which we prize, it also serves as a sort of tracer bullet to let us see the trajectory of the path of the market.
The only change we may make in our clients' portfolios is that for clients in the top tax bracket we may suggest they switch to our Capital Builder investment style, which features lower dividend yielding stocks whose dividends are growing much faster than the average company. The overall performance difference between Capital Builder and Cornerstone (our higher yielding, lower dividend growth investment style) has been very small.
Wednesday, November 05, 2008
Does Obama's Tax Plan Change Our View of Dividends?
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2 comments:
Great Post! At various points, Obama mentioned that only households that made over 250K would see higher taxes. I even saw one of his financial advisors indicate this would extend to dividends. The big question: Will we keep the 15% div tax rate for households making less than 250K or will the 15% rate get increased for everyone?
Following an historic election, let's take a moment to examine just what an Obama presidency will mean to the United States - what we have to look forward to, and how he will deal with our current economic issues. According Jim Davidson, some of the numbers just don’t add up:
"One of Obama’s specific proposals is to raise the capital gains and dividend taxes to 25%, which will sharply increase capital confiscation as increasing percentages of “gains” will reflect inflationary depreciation of the currency. In the U.S., an investor must pay tax on the difference between the sales price of an asset and it purchase price, with no adjustment for inflation. Consequently, when the tax rate and inflation are high, a large portion of the “capital gain” is illusory. Any asset that appreciates by less than the rate of inflation will result in its owner losing purchasing power and having to pay taxes on the illusory gains. At Obama’s higher tax rates, (he has suggested that capital gains and dividend taxes should be hiked to as much as 25%,) capital confiscation would result from modest levels of inflation.
And the Great Credit Crunch implies that inflation will be far higher than in recent experience.
Setting aside whether it is moral or equitable to force a small fraction of the population to essentially pay for the whole cost of government, much of which entails the shuffling of checks to purchase votes of various aggrieved groups, there is a bigger question. Can it be wise for the whole fiscal regime to stand on the shoulders of a small group, like a pyramid tottering on its point, so that any tribulation which undermines the prosperity of those who pay would promise to bankrupt the state?"
The Danger Lurking Behind Obama’s Tax Policy
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