Viewing the Market Selloff from the Perspective of a Dividend Investor

By Greg Donaldson and Mike Hull Yesterday's 300 point loss in the Dow is not the end of the stock market nor the demise of our clients' assets. Every time the stock prices fall like water out of a boot, everyone throws their hands in the air and tries to shield themselves from the pieces of sky that surely must be falling. The sky is not falling, and neither will every bank in America collapse in the face of the housing debacle. Stock prices will gyrate and the media will pontificate on all the things that are wrong, but that is their way -- to fan the fires, so they can sell more kindling. We listened to three earnings calls this week: Wachovia, Wells Fargo, and Bank of America. These are three of the largest banks in the county, and all are deeply involved in the mortgage market. None of these companies said they were seeing big increases in their non-performing credits, and none said that they were experiencing big defaults in their loan portfolios. Two of the companies, Wells Fargo and Bank of America, signaled their confidence in the future by hiking their dividends, 11% and 14% respectively. How can these companies raise their dividends in the face of all this bad news and falling stock prices? Two answers: 1) These companies have strong balance sheets and their earnings are good. They are confident that they will come through this challenging mortgage market just as strong, if not stronger, than they are today. 2) They know that stock prices have nothing to do with their fundamental businesses. We love dividends because they ignore what is going on today. They reflect, in large part, the track record of the company paying them, and they give us wonderful insight into what their leaders believe about the future. This week Bank of America raised its dividend 14%, to $2.56. That means that an investor buying BAC today could expect to receive a yield of 5.4% in dividends over the next twelve months. And, we're betting BAC will raise that dividend by at least 7% per year year over the next decade. At that rate of growth, BAC's dividend in 10 years would rise to $5.12 per share. That would mean that based on today's price of $47 per share, in 10 years, BAC would be offering a yield on today's cost of 10.8% ($5.12/$47). Now let's compare that to a riskless 10-year US Treasury bond. Today the yield on a 10-year T-bond is 4.8%. BAC's current dividend yield of 5.4% is higher, but let's face it T-bonds have no risk, so based on yield alone we would not choose BAC over the T-bond. However, when we factor in the dividend growth of only 7%, which is much less than their dividend growth over the past decade, BAC offers a much better potential total rate of return over the coming decade. We would be much more worried about the economy if the major banks were not in such good financial shape. All three of the banks we mentioned earlier have at least a AA rating, as reported by Bloomberg. These are solid outfits run by seasoned managers. These companies, like so many of our other "Rising Dividend" companies, are attractive just from their dividends alone. However, when you add in the their prospects for future dividend growth, they are tough to beat by pure growth investments. Pure growth investing requires that an investor buy right and sell right because the timing of these two actions determines the entire rate of return. That is why the stock market is correcting right now. For traders, when the markets start to fall like they have this week, they must sell out fast or risk losing all of their gains. With dividend investing, our rate of return is much more a function of the cash flows that we receive while we "own" the stock. Thus, from the perspective of we dividend investors, if we are happy with the dividend growth and financial strength of a company we own, a big selloff in stocks is an opportunity to add to our positions and look for other solid, dividend-paying companies that the market is "putting on sale." The panic of the day will scare the traders and they will do what they always do-- run -- and this correction in the market may last a while longer. In the end, however, cooler heads will do their homework and conclude that many stocks are too cheap, and that the mortgage mess in this country will pass, like all the crises before it.