The great stock market crash which lasted from September 2008 to April 2009 was a traumatizing event for most investors, including our clients. The extent of the carnage was appalling. All the major North American indices fell about 50%, with the S&P 500 index of the largest companies in the U.S. falling a scary 56% from peak to trough. Many investors saw the market value of their portfolios lose anywhere from 35% to 50% in a seven month period. We have now had ten years to reflect on what happened, and I want to point out the important lessons that we learned.
As value investors, we like stocks that pay dividends. Going into the market crash in 2008, we owned about 50 stocks. (No one client owned all 50, of course, since we tailor our portfolios according to the investment goals and needs of each family). Of the 50 stocks we owned at that time, 47 were dividend payers. During the greatest financial crisis in over 70 years, of those 47 dividend payers, only one cut its dividend. The other 46 kept paying at the same rate, except for the ones that increased dividends in spite of the crisis. For income seeking investors, the market crash was largely a non-event. They continued to receive the cash flow they expected.
Warren Buffet has pointed out that stock prices are only relevant when you are buying or selling. The rest of the time, stock markets provide interesting and potentially useful information on a minute by minute basis; but if you are not planning to change what you own, changes in market prices don’t make you richer or poorer (although we may certainly feel richer or poorer). Dividends, on the other hand, are real. They are cash in hand, paid four times a year, regardless of what the market might be doing.
So what did we learn? The following are the main take-aways:
- Quality companies work very hard to maintain dividends. The fact that only one of our 47 payers cut its dividend testifies not only to the strong balance sheets, sustainable dividend payout ratios and steady income of our holdings, but also to the dogged determination of most companies to never cut dividends.
- Dividends are more durable and much less volatile than stock prices. Stock prices go up and down all the time. Dividends mostly go up. Some companies raise them every year.
- For conservative investors, cash flow is more important than market value. You can’t pay the rent or buy groceries with unrealized market gains; and unrealized market losses won’t affect that cash flow. When it comes to paying the bills, cash is king.
Following the sharp market sell-off in the fourth quarter of 2018, we saw dividend yields rise to very high levels on a number of quality stocks. Even after the sharp recovery so far in 2019, here are the yields on several companies we follow:
- Bank of Nova Scotia 4.78%
- Power Corporation 5.97%
- TransCanada Corp 5.13%
- BCE 5.48%
- Keyera 6.41%
We would be shocked if any one of these companies cut its dividend in the near future. We would also be surprised if at least three or four did not increase the dividend during 2019.
While each investor has her or his own goals, our view is that dividends should be a part of everyone’s plan. Over time, dividends have contributed more than half the return on the TSX total return index. Investing only for capital gains means one has to be a very, very good stock-picker indeed. At the moment, we have a rare and unusual situation. Dividends on high quality stocks such as those shown above yield more than twice the interest rate on the 10 year Canada bond, currently about 1.95%. This seems to be an unsustainable situation that can only change in three ways:
- Interest rates on bonds could rise to 3% or 4%, making dividend yields less attractive. This seems quite unlikely given the stage of the business cycle and the actions of central bankers in Canada and the U.S.;
- Companies could cut their dividends by 50%, taking yields down to levels similar to 10 year bonds. This would be unprecedented; we view the likelihood of this as close to zero;
- Stock prices on high yield stocks could rise, thereby reducing the dividend yields to a more normal level in relation to bonds. We consider this to be the most likely scenario.
Everyone would like to pick the next Amazon or Netflix and see capital gains of 1,000%. We are not against the idea, but recognize the difficulty and rarity of doing that on a regular basis. In contrast, everyone can and should lock in high and rising yields on high quality companies when the opportunity arises. Just because it’s easy and obvious doesn’t mean it is not the smart thing to do.