The Case Against High Dividend Stocks in Retirement

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?
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Springbok
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Re: The Case Against High Dividend Stocks in Retirement

Post by Springbok »

Quebec wrote:
StuBee wrote: you have to have a darn good idea of the future dividend growth rate... StuBee
That's why the model works better for the past than the future! But for a mature dividend-paying company with a long history of regular dividend increases, nothing special going on within the company or it's markets, and consistent top-line and bottom-line growth, it's not totally unreasonable to assume that past trends may continue for another 5-10 years.
I recall buying Loblaws, Manulife and one or two others using that thinking :(

At the time I thought those would help diversify a portfolio that was too high in energy & materials :(
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Re: The Case Against High Dividend Stocks in Retirement

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For the average unsophisticated investor (read "me") clearly we are at risk of making poor choices. Indeed, (and at the risk of repeating myself) no one can possibly know the future...What we do need to know, we don't know...and what we already know, we don't need to know...

In my case I have adopted a sort of "market knows best" attitude. IMHO over a sufficiently large number of different companies (i.e. diversify!) the Gordon growth model can be loosely applied. As Shakespeare said, long term growth will (on average) approximate the economy. There is not much I can do about that...So if current income interests me, I purchase high yield (in a prudent manner (not blindly)). If future income interests me I purchase a lower yield (once again in a prudent manner) because in this manner, I will be purchasing dividend growth (in accordance with a loose application of the Gordon growth model).

I believe that in my situation a "happy" average portfolio yield would (currently) be around 3.5%. I am now around 4.3% a bit high but it would have been 25 bps lower if ENB hadn't increased their dividend :P . If I was younger I might tend to stocks with a lower yield (SNC comes to mind). If I was much older I would tend to overweight stocks with a significantly above average yield (TA comes to mind).

I consider this to be a relatively simple and safe way to invest in stocks. Great for me the average unsophisticated investor. :wink:

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Re: The Case Against High Dividend Stocks in Retirement

Post by Springbok »

Shakespeare wrote:
FWIW my Canadian stock portfolio [excluding REITs and trusts] has a weighted yield of 4% at present.
I had never worked that out before - My stock portfolio figures are 3.48% without and 5.38% with trusts/REITs. But leaving out trusts these days doesn't make much sense. A number of my stocks were trusts a few months ago.

I do have a resistance to buying good companies like CWB and CT because of their low dividends vs other stalwarts like the major banks, BCE, Telus etc. They all ride the same rollercoaster. My over all stock yield is low because of good size positions in a few non-dividend payers that have fortunately had substantial growth (e.g. EQN, XGD) and too much sitting dead in XIC (since sold)
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Re: The Case Against High Dividend Stocks in Retirement

Post by MaxFax »

Ref
Gordon Growth Model = Dividend$(1+g)/(r-g)

This is the basic model used for valuing dividend-paying common stocks.
Their dividend payments are discounted back to the present.
Only one growth rate is assumed - to continue in perpetuity.

Inputs
$2.50 Dividend$ today (not forward year's)
7.0% Growth rate of payments (g)
10.0% Rate of return required (discount rate r)

Resulting valuation using Gordon model:
The stock is worth: $89.17
showing a 2.8% dividend yield.


Investors may kid themselves into thinking they are deriving a more 'exact' valuation by using models that presume an initial growth phase followed by a slower mature phase. Ever single stock they look at is considered to be growing at a higher rate than is sustainable. Yeh, right! The reality is that the growth rate is a VERY, VERY, VERY rough estimate. There is no way anyone can predict the growth in years's 6-100. The future is unknown. You cannot make any model 'more exact' by simply guessing different numbers.


The other simple models for valuing stocks depend on Earnings $$ instead of Dividends $$. You can reconsile the different models by deriving the ROE of the reinvested earnings that is necessary to generate the original estimate of growth. As you can see below there are huge differences in the required ROE. Conclusion - these models are toooooo simple to be useful. They produce different valuations, none of which is probably 'true'.


Compare the resulting valuation assuming different Price/Earnings multiples
If P/E = 10 : Earnings would be = $8.92
% earnings retained = 72%
Incremental ROE necessary to generate growth = 9.7%

If P/E = 15 Earnings would be = $5.94
% earnings retained = 58%
Incremental ROE necessary to generate growth = 12.1%

Using Benjamin Graham's formula for appropriate P/E
P/E = 8.5 + (2*g) = 22.50
Earnings would be = $3.96
% earnings retained = 37%
Incremental ROE necessary to generate growth = 19.0%

Using P/E derived from PEG ratio = 1
then P/E = g = 7
Earnings would be = $12.74
% earnings retained = 80%
Incremental ROE necessary to generate growth = 8.7%
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Re: The Case Against High Dividend Stocks in Retirement

Post by Taggart »

Shakespeare wrote:I'm not sure P/B is as meaningful nowadays, with the greater importance of intellectual capital. Also, trains of mergers and acquisitions produce questionable book value that is often a matter of opinion.
I still use price to tangible book value as "one" of my valuation metrics, but only in North America, not on international stocks.
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Re: The Case Against High Dividend Stocks in Retirement

Post by Quebec »

Springbok wrote:I recall buying Loblaws, Manulife and one or two others using that thinking :(
Hummmm. I've made similar mistakes too over the last few years:

- Following my recommendation, my wife bought Manulife high (before the financial crisis) and sold it low (right after the dividend cut).

- I purchased Home Depot high (before the US housing crisis) and sold it low recently after giving up all hope of breaking even in a reasonable time. The remaining capital has found a better home now.

In both cases, past dividend growth (mentally extrapolated into the future) was one of the criteria (among many) I used to make my selection. The dividend growth did not continue into the future.

Fortunately the great majority of my stock picks have been happier experiences so far. Nevertheless as time passes I've become busier (young baby, etc.) and a little humbler (learning from mistakes) which has led me to put more money in broad ETFs and less in individual stocks. I now aim for no more than 25% of the portfolio in individual stocks.
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Re: The Case Against High Dividend Stocks in Retirement

Post by Taggart »

Quebec wrote:
Springbok wrote:I recall buying Loblaws, Manulife and one or two others using that thinking :(
Hummmm. I've made similar mistakes too over the last few years:

- Following my recommendation, my wife bought Manulife high (before the financial crisis) and sold it low (right after the dividend cut).

- I purchased Home Depot high (before the US housing crisis) and sold it low recently after giving up all hope of breaking even in a reasonable time. The remaining capital has found a better home now.

In both cases, past dividend growth (mentally extrapolated into the future) was one of the criteria (among many) I used to make my selection. The dividend growth did not continue into the future.

Fortunately the great majority of my stock picks have been happier experiences so far. Nevertheless as time passes I've become busier (young baby, etc.) and a little humbler (learning from mistakes) which has led me to put more money in broad ETFs and less in individual stocks. I now aim for no more than 25% of the portfolio in individual stocks.


I'm the opposite. As the years wear on, I'm getting more and more disgruntled with ETF's and more satisfied with my individual stock selections. I don't think of myself as a great stockpicker either. When things are going well with the investments, then that's the time to start worrying.
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Re: The Case Against High Dividend Stocks in Retirement

Post by kcowan »

Springbok wrote:I recall buying Loblaws, Manulife and one or two others using that thinking :(

At the time I thought those would help diversify a portfolio that was too high in energy & materials :(
But diversifying a portfolio will reduce the return. The idea behind diversity is to reduce risk but in so doing, you will also reduce average returns.

Now maybe buying a retail ETF would be better than buying Loblaws if you have little expertise in the sector. My main exposure to retail is THI and LLL. And I know those are risky holds. But I am willing to take the risks for the potential returns.
For the fun of it...Keith
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Re: The Case Against High Dividend Stocks in Retirement

Post by Quebec »

David Stanley in the October issue of CMS:
Hyping dividend investing has become a growth industry. One can hardly pick up the finance section of a newspaper or watch BNN without getting a steady parade of reborn advisors preaching the advantages of purchasing dividend-paying stocks. (...) I have my suspicions, however, that come the next bull market those same folks will be back on the momentum bandwagon.
One way to approximate the future value of an investment is the Gordon Growth Model. This model was developed in 1959 by Dr. Myron J. Gordon, an economics professor at the University of Toronto. (...) The model for which he was famous is based on determining the value of a future series of dividends that grow at a constant rate. In essence, the Gordon Growth Model asserts that the total return of a stock investment will equal its current dividend yield plus its dividend growth rate. Applying this concept to the data in Table 1 would lead one to think that banks would outperform utilities since banks have had a much higher rate of dividend growth in the past. However, we must remember that we are in the “New Normal” and dividend growth rates may slow in the future.
Added: although I've enjoyed reading CMS in the past, and learned some useful tips (e.g., the series on life insurance around year 1993 and then 2001-2002 was excellent and I've used term4sale.ca recently to get quotes for my wife's policy before we contacted an agent), I am not too happy with this year's volume:
- Lots of pages of useless tables (top performing mutual funds or ETFs or whatever, I don't care); e.g., 6 such pages in the October issue
- Constant promotion for cruises that I'm not gonna attend
- Promotion (in the editorial!!) for a certain real estate development in the Riviera Maya: hummmmmmmmm!
- Articles by Derek Foster
- etc.
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Re: The Case Against High Dividend Stocks in Retirement

Post by MaxFax »

Was that really a David Stanley quote: "Hyping dividend investing has become a growth industry.... a steady parade .. preaching the advantages of ...dividend-paying stocks." ?? Seems to my memory that it has been himself promoting dividends using the false math of "next-1yr'sDiv / historicalCostAgesAgo". Even if it wasn't him personally, the newsletter has historically been the worst offender of "dividend hype". And he chose to be part of it.

When I have read the newsletter, I too have found the insurance articles helpful BUT it may well be that my opinion is ONLY because I don't know enough about insurance to know what is right/wrong. I DO enough about investing to find their investing articles un-dependable.
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Re: The Case Against High Dividend Stocks in Retirement

Post by like_to_retire »

Quebec wrote:Added: although I've enjoyed reading CMS in the past, and learned some useful tips (e.g., the series on life insurance around year 1993 and then 2001-2002 was excellent and I've used term4sale.ca recently to get quotes for my wife's policy before we contacted an agent), I am not too happy with this year's volume:
- Lots of pages of useless tables (top performing mutual funds or ETFs or whatever, I don't care); e.g., 6 such pages in the October issue
- Constant promotion for cruises that I'm not gonna attend
- Promotion (in the editorial!!) for a certain real estate development in the Riviera Maya: hummmmmmmmm!
- Articles by Derek Foster
- etc.
Yeah, I agree. I've subscribed to CMS (Canadian Money Saver) for many years and find myself in the last year musing about not renewing. Less articles are appealing to me, not to mention the list you provded in your quote.

ltr
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Re: The Case Against High Dividend Stocks in Retirement

Post by Eric R »

IMHO the issue of dividend paying versus non-dividend paying stocks has to be taken in the context of asset allocation. In a portfolio which consists of pure growth stocks and FI (let's say 50/50) that is rebalanced at least once a year, stocks will generally be sold when they are dear and bought when they are cheap. So the volatility actually increased the returns and provides opportunity. In a sideways market this opportunity shrinks for growth stocks (while dividends keep flowing in).

A portfolio of value/dividend stocks should be treated similarly, taking into account the cash dividends, but given that these stocks are less volatile, gains from rebalancing would be at best modest even in volatile markets. I do not know if having a dividend tilt would allow for a greater allocation to equity, but my guess is that it shouldn't be substantially different (since in bear markets dividends may be cut or not grow), in which case overall there should not be much of a difference in return, given that 90% of a portfolio's returns are determined by asset allocation and the markets are likely efficient for the average investor.

FWIW, I prefer to have my equity portion allocated 1/3 to S&P500, 1/3 to total international stock market, and 1/3 to Canadian equities. This part I tilt towards dividend-payers, not in order to outperform the market, but for their tax-advantage (these are all in a CCPC).

I personally view XIC/XIU as a low-yield dividend payer with moderate growth prospects) and I think overall is a good balance between value and growth.
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Re: The Case Against High Dividend Stocks in Retirement

Post by adrian2 »

Quebec wrote:I purchased Home Depot high (before the US housing crisis) and sold it low recently after giving up all hope of breaking even in a reasonable time. The remaining capital has found a better home now.
But not a depot? Sorry, could not resist the pun.
Quebec wrote:Nevertheless as time passes I've become busier (young baby, etc.) and a little humbler (learning from mistakes) which has led me to put more money in broad ETFs and less in individual stocks. I now aim for no more than 25% of the portfolio in individual stocks.
I'm with Taggart on this (and probably many other issues). Few of the new investments in the past years have gone into ETF's.
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Re: The Case Against High Dividend Stocks in Retirement

Post by Quebec »

To complete the CMS story, there is an interesting survey of readers in this month's edition (Jan 2011). The following is a partial quote from this survey:

Code: Select all

RATE THE FOLLOWING INVESTMENT TOPICS
                     Most Importance   Average Importance   Least Importance
Retirement Planning  63.9%             27.8%                8.2%
Life Insurance       8.5%              31.9%                59.6%
Estate Planning      44.8%             37.5%                17.7%

RATE CANADIAN MONEYSAVER REGULAR FEATURES
                     Most Importance   Average Importance   Least Importance
Top Funds            24.7%             28.9%                46.4%
MoneySaver Events    16.7%             47.9%                35.4%

AGE
Under 25   1%
25-40      6%
41-55      38%
56-65      38%
65 plus    17%
So the average reader is thinking about retirement and even estate planning, but too old to need to purchase life insurance. And many readers do seem to enjoy some of the features I was complaining about, such as tables of data for top performing mutual funds. I personally think a table of "top funds" is not only wasted space, it's also actually dangerous, as someone may want to use it to make investment decisions (e.g., pick last year's winner). But more than half the readership finds this feature of "average importance" or better. So maybe the editor is just giving the readers what they want.

Anyway as a true "Moneysaver" I'm only subscribing to CMS every other year (with the online edition you get access to archives as well as one year of incoming issues), therefore I'm paying maximum $15 a year and shouldn't be complaining too much, as once in a while there is something useful in there. One example for 2010 was the article on Charity Intelligence Canada.
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Re: The Case Against High Dividend Stocks in Retirement

Post by UUi11 »

Quebec,

Can you give a summary on the article? Is Charity Intelligence a good site?

Thanks
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Re: The Case Against High Dividend Stocks in Retirement

Post by Quebec »

"Charity Intelligence" is a charity. They analyze other charities according to a list of criteria, financial and non-financial. There are similarities to fundamental analysis of stocks, but from a different point of view (maximum benefits to the community/"clients", rather than maximum shareholder profit). They pick the "best" charities according to their criteria, and list them on their site. You can use this information as you wish, or you can make a donation to Charity Intelligence either to support their research, or so they forward it to their "top picks". I find their analytical approach very interesting.

(My only complain was that no Quebec-based charities were selected as "top picks", which suggests few were analyzed, perhaps because of the language barrier. Also their website is not bilingual, which will reduce their influence in this province. I wrote to Charity Intelligence about this but got no reply, so I gave up on them; otherwise, I might have sent a cheque)
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Re: The Case Against High Dividend Stocks in Retirement

Post by vince2 »

I note that James Montier has also weighed in on the subject that Dividends still matter and he stresses the following:

1. .......as the time horizon is extended, “fundamentals” play an increasing role in
return generation. For example, at a 5-year time horizon, dividend yield and dividend growth account for almost 80% of the return.
2. This is not only true for the USA, but even more so for Europe.
3. They tend to track inflation relatively well over periods greater than 5 years.

My portfolio is heavily tilted towards dividend paying companies and I believe that I have structured it as well I possibly could with a mixture of stocks consisting of high dividend payers but little expected dividend growth with low dividend payers but higher expected dividend growth. I have very little RRSP room to fill with Bonds and have progressively filled the fixed income part with preferreds and will continue to do so.

Fortunately my risk capacity is relatively high although my risk tolerance is probably somewhat average. I have a 10 year bond ladder but do not see it as an income producer but rather as insurance.
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