Sunday, August 26, 2007

Dividends Do it Again

The recent meltdown of the subprime mortgage business has caused stocks in the US, as measured by the S&P 500 Index, to fall by 1.9% over the last 30 days. That return, however, as poor as it is, is mild compared to the return of the average stock in S&P 500 Index, which has fallen 3.7%. This disparity between the rate of return of the Index itself and that of the average stock in the Index means that stocks with higher market capitalizations have performed better during the sell off than smaller members of the Index. In addition to the larger companies doing better than smaller companies in the index during the last 30 days, the rates of return by dividend yield is very telling. Indeed, breaking the 500 stocks into quintiles shows a remarkable inverse relationship between dividend yield and average loss.
  1. Top 100 highest yielding stocks -1.4%
  2. Next 100 highest yielding stocks -2.8%
  3. Next 100 highest yielding stocks -3.6%
  4. Next 100 highest yielding stocks -3.6%
  5. Lowest 100 yielding stocks . . . . . -7.1%

The inverse relationship is very tight with stocks with the lowest dividend yields performing the worst and stocks with the highest dividend yields faring the best.

One might conclude that this is the way it ought to be because higher yielding stocks are more mature and usually more creditworthy, but that would miss the point that many REITs and Banks are included in the highest yielding quintiles, and these sectors, initially, took a solid thumping before recovering.

My conclusion is going to sound familiar: dividend paying stocks are easier to value because a good portion of their rate of return is produced by their dividend, thus, in a manner of speaking they are more transparent.

Speaking of transparent, that will be the key word to describe the recent subprime mess. Too many companies were more deeply involved in the subprime market of one variety or another than they disclosed in their quarterly and annual reports. When management is playing fast and loose with their shareholders' capital and not disclosing it, it is a breech of trust and they deserve to be fired without benefit of the usual golden severance package. I'll have more to say on this in the coming weeks.