In a somewhat historic turn of events, the recent decline in the stock market and simultaneous rise in bond prices has caused the average common stock to provide more income than that paid by U.S. Treasury bonds. This is the first time this has occurred in more than 50 years.
Keep in mind, that as Treasury bond prices rise due to demand by investors seeking safety, the dollar value of interest promised to be paid to the bond-owner becomes a lower percentage of the bond price. The level of fear recently has been quite high and the ensuing scramble to own treasuries has driven prices up to the point where a buyer of a 10-year treasury bond today would lock in a yield of about 2.75 percent annually until the bond matures. Thirty-year bonds yield slightly more at about 3.1 percent.
These are not very good rewards to the investor, but at present, many are more worried about return of their principal, rather than return on their principal, and bonds issued by the U.S. government are considered to have the ultimate guarantee of return of principal.
When stock prices move up or down, the percentage yield of the current dollar value of the dividend stream varies with the direction and extent of the price fluctuation. The recent decline in stock prices means that the yield of the dollar value of the dividend payments is a higher percentage. The move down in stock prices and up in bond prices has gone to the extent where a portfolio of stocks may yield significantly more that 10- and 30-year Treasury bonds.
The dividend yield on the S&P 500 index has now risen to about 2.9 percent. However, ignoring the 128 stocks in the S&P 500 which pay no dividends at all would reveal a yield on the 372 remaining companies of about 3.9 percent (data from www.indexarb.com). My firm’s Elite Dividend Portfolio, a group of about 40 dividend paying common stocks, currently yields about 3.2 percent, although, we target growth of dividends rather that the highest yielding companies.
What is the significance of common stocks yielding more than bonds? In my opinion, it is a sign of the level of investor fear and likely an indication that stocks are very undervalued compared to bonds. Of course, this condition could last for a while longer and fluctuations in stock prices tend to be greater than those observed in bonds most of the time.
For the long-term oriented investor, I would make the observation that a diversified portfolio of high quality, dividend paying companies can provide more income that Treasury bonds, and about the same income stream as that of a certificate of deposit, while offering the potential for both price appreciation over time and increases to the dollar value of the dividend payout as companies continue to grow and share profits with shareholders over time. Of course, the investor must acknowledge the risk of higher price volatility and the potential that an individual company could reduce its dividend payment. Also, individual companies have the potential for failure (bankruptcy).
For these reasons, I believe higher quality companies with sound balance sheets might be a better investment than going after the absolute highest yields. Diversifying to reduce company specific risk is also a requirement for a sound portfolio.
Tom Breiter is President of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing.