Myth Busters - Dividend Stocks Are Safe
In recent years, many investors have been attracted to the "safety" and "wealth-building" appeal of dividend stocks. Therefore, it is prudent to examine history and ask:
Will my net worth take a big hit holding blue-chip dividend payers in the next bear market?
Before we explore the facts, it is important to understand that well-intentioned investors have a habit of repeating the same mistakes over and over again. If we understand the propensity to make mistakes, it is more likely we can reduce the odds of taking a hard-to-recover-from blow to our retirement nest egg and/or estate. Is it a mistake to think of dividend stocks as safe? You can decide after reviewing the evidence.
Dividend Investors Making A Common Mistake
Why did we have a tulip bulb mania in the 1660s, a dot-com bubble in the 1990s, and a housing bubble in the late 2000s? The human emotions of greed and fear have not changed the last 400 years. To refresh our memories, a quick read of the segment below from an April 2000 BusinessWeek article is in order:
Around 1624, the Amsterdam man who owned the only dozen specimens was offered 3,000 guilders for one bulb. While there's no accurate way to render that in today's greenbacks, the sum was roughly equal to the annual income of a wealthy merchant. In recent years, as investors have intentionally forgotten everything they learned in Investing 101 in order to load up on unproved, unprofitable dot-com issues, tulip mania has been invoked frequently.
Just The Facts Ma'am
Rather than pontificate about the pros and cons of holding dividend stocks, it is best to focus on their performance in the last bear market. Our intent here is not to criticize any article or piece of well-intentioned investment research, but rather to educate investors about the downside risks associated with a buy-and-hold strategy in "safe and reliable" dividend paying stocks.
The 10 Most Popular High-Yielding Dividend Stocks
Our first list of dividend payers was compiled based on the concern that a stock market correction is overdue. The list includes Unilever (UN), General Electric (GE), ConocoPhillips (COP), Vodafone (VOD), Johnson & Johnson (JNJ), Sysco (SYY), Pfizer (PFE), Merck (MRK), Eli Lilly (LLY), and Glaxo SmithKline (GSK). Corrections are followed by rallies to new highs. Therefore, a buy-and-hold strategy can work well during a normal market correction. However, the real test of wealth preservation comes in a bear market. The blurb below from The Street describes the list of 10 stocks that follows:
Concerns that a stock market correction is overdue may be turning investors, particularly those near or in retirement, into yield hounds... In addressing that interest, ratings and research firm Morningstar, which tracks the portfolio changes of 26 top-performing mutual funds for its "Ultimate Stock-Pickers" series, screened its funds list. It found the most dividend-focused funds with stocks that pay an annual yield greater than that of the S&P 500's 2% for last year...Here are the 10 most popular high-yielding dividend stocks among Morningstar's Ultimate Stock-Pickers funds, listed in inverse order of highest yield.
How would we have done in the last bear market with these 10 stocks using a buy-and-hold approach? The table below shows the closing prices for each stock at the bull market peak, October 9, 2007, and the bear market bottom, March 9, 2009.
A False Sense Of Security
Our next list of dividend payers comes from a July 2013 article on Yahoo Finance:
So, what's the appeal? For one: security. A blue-chip stock gives you equity in a large, reputable and financially sound company with a long history. Their stocks are attractive not only because of their familiarity, but because they tend to be less volatile and have a record of paying stable or rising dividends (read: extra money in your pocket) for years, if not decades...we've highlighted 10 popular, widely held stocks.
The list includes McDonald's (MCD), Coca-Cola (KO), Wal-Mart (WMT), General Electric (GE), Procter & Gamble (PG), Microsoft (MSFT), AT&T (T), Walt Disney (DIS), Wells Fargo (WFC), and Johnson & Johnson (JNJ). We have to give the author some credit; she did point out that "all investing comes with risk and blue-chip stocks can still lose significant value." The performance of the ten stocks during the last financial crisis illustrates the real world risks associated with any buy-and-hold investment approach.
How About A Data-Based Stock Screen?
The list below shows the performance of the "Top Rated Dividend Paying Stocks" on Dividata.com; it includes Monmouth Real Estate (MNR), Landauer (LDR), Leggett & Platt (LEG), Universal (UVV), Courier (CRRC), Kinder Morgan (KMP), Universal Health (UHT), HCP (HCP), Hawaiian Electric (HE), and Mercury General (MCY).
Help You Navigate To Retirement?
The list below was referenced as a way to "navigate" to retirement; it includes Kimberly-Clark (KMB), Johnson & Johnson (JNJ), McDonald's (MCD), Chevron (CVX), and HCP (HCP). Can you imagine if you lost 34% the year before you were due to retire?
Good Dividend Payers To Buy On Dips
This list below is comprised of common dividend names that have been written about in recent months as potential buy candidates for blue-chip investors. The list includes International Business Machines (IBM), Target (TGT), Mattel (MAT), Aflac (AFL), Aqua America (WTR), Ford (F), Bristol-Myers (BMY), Consumer Staples ETF (XLP), Altria Group (MO), General Mills (GIS), Kimberly-Clark (KMB), Pepsico (PEP), Clorox (CLX), Health Care ETF (XLV), Johnson & Johnson (JNJ), Merck (MRK), Baxter International (BAX), and Owens & Minor (OMI). The average loss during the last bear market for these stocks was over 36%.
Safe Stocks For A Market 'Storm'
The last list was published on Forbes.com with the title "12 Safe Dividend Stocks For The Market Storm". The list includes Reynolds America (RAI), Coca-Cola (KO), Southern Copper (SCCO), Eli Lilly (LLY), H&R Block (HRB), Leggett & Platt (LEG), Lockheed Martin (LMT), Paychex (PAYX), Pearson (PSO), Cinemark (CNK), STMicroelectronics (STM), and United Parcel Service (UPS). These safe haven dividend payers lost 47% during the last bear market.
Are Dividend Strategies Useful?
Dividend strategies can be very useful and add value for investors. The hole in some of these dividend strategies is they focus exclusively on when to buy. As noted on Twitter, when to buy is important, but it is less than half the investment battle.
Adding Risk Management To The Equation
An investment game plan that does not include an exit or a risk-reduction strategy leaves the investor open to hard-to-recover-from losses. The previous statement applies to any dividend-based investment approach. There are 54 different dividend stocks shown in the lists above. The table below shows the performance of the 54 stocks between October 9, 2007 and March 9, 2009. Since the share prices are adjusted for dividends, the figures below account for income payments, which shows dividends will not save an investor in a bear market.
More on prices that are adjusted for dividends From Yahoo Finance:
Adjusted Close provides the closing price for the requested day, week, or month, adjusted for all applicable splits and dividend distributions. Data is adjusted using appropriate split and dividend multipliers, adhering to Center for Research in Security Prices (CRSP) standards.
Investopedia expands on the benefit of using adjusted closing prices, as we did in this analysis:
The adjusted closing price is a useful tool when examining historical returns because it gives analysts an accurate representation of the firm's equity value beyond the simple market price. It accounts for all corporate actions such as stock splits, dividends/distributions and rights offerings.
Was The Financial Crisis Unique?
No, the S&P 500 lost over 50% in both the dot-com bear market and the financial crisis bear market. As shown in the chart below, three years of stock market gains were wiped out in the 2000-2002 bear market.
Of the 54 stocks studied above, 53 of them were in existence during the dot-com bust. The blue-chip heavy Dow Jones Industrial Average (Dow) peaked on January 14, 2000. The Dow found a bottom on October 9, 2002. Over that period, some dividend stocks added significant value. However, 66% of the 53 dividend paying stocks lost money during the 2000-2002 bear market. Of those 66%, the average loss was 13.58% (based on adjusted closing prices).
Is There Anything Investors Can Do?
While there is no magic investing bullet, there are things that investors can do to mitigate (not eliminate) risk during a bear market. It is important that any investment strategy have a "when to prudently buy" and a "when to prudently sell or reduce risk" component. Risk management topics that can be paired with any stock-based strategy have been covered numerous times in the past, including in the articles listed below:
- Managing Risk In A Mature Bull Market
- Scared Of Stocks? There Are Ways To Monitor Risk
- Investors Must Know How We Got Here And Where We Are Going
- Want To Reduce Missteps? Become A Two-Faced Investor
- You Need A Plan For Next Inevitable Bear Market
DRIPS Are Buy And Hold
Another often recommended way to invest in dividend stocks is via dividend reinvestment plans or DRIPS. DRIPS have many benefits (low cost, disciplined, consistent), but they also are a form of buy-and-hold unless paired with some type of risk management strategy. Therefore, DRIPS are not a fool proof method for wealth preservation during a bear market. If the returns for dividend stocks during bear markets shown above are concerning, then DRIPS are concerning as well.
Benefits Of Dividend And Blue Chip Investing
All stocks carry risk, including blue-chip dividend stocks. Having said that there are numerous benefits to investing in blue-chippers, such as consistent dividends, established brands, top-tier management, access to DRIPS, and in some cases, substantially lower volatility relative to the broad stock market. If we understand the pros and cons of any investment option, we are more likely to make better risk management decisions.
