Friday, June 1, 2012

Reply to Mike

The Question

"I am struggling with the question “Am I making money in the stock market?” Because of the current state of the market, my portfolio is down, but then I am still getting dividend income on a regular basis. Am I making money because I am receiving dividend income? Perhaps the dividend income is really like return of capital. Say your portfolio is down 15% and you are getting 4% dividend. It is like taking money from your portfolio and paying yourself as dividend. I cannot be making money if I add up the value of my portfolio and the dividend received, and the total amount is less than what I originally invested.

My Answer

The thing with investing in stocks is that the value of the stocks can fluctuate a lot. However, all you are getting are paper losses or gains until you actually sell a stock. If you have good dividend paying stocks, their value should rise over time.

I think that I am making money as I keep track of the ability of the companies I invest in to pay their dividends. If a company is earning money and can afford dividends I do not worry. The value of a company can vary because of a lot of factors, not just a company’s ability to earning money and pay dividends. When I company I own has a stock price treading downward and I do not panic and sell, I will only have a paper loss, not a real one.

Another idea about dividends is that you are being paid to wait for better stock prices. For most stock markets, the stock prices will rise over time. (Although this is probably only true for Anglo-Saxon countries; as they have a better record on bankruptcy than other countries. However, this is a whole other subject.) On your typical dividend paying stock, the stock will tend to rise at the same rate, over the long term, as the growth in dividends.

Actually, dividend payments can be a return of capital in some instances. That is when the Dividend Payout Ratio for earnings is above100%. In this case, the book value will trend down. It is probably fine if this occurs on a short term basis. I would be very worried if 5 year median DPR for earnings was 100% or above. However, you should also view such a company with regards to the DPR for cash flow as well.

And, horrors of horrors I have heard stories of companies borrowing to buy dividends. This is really bad.

REITs have a different basis for deciding what they can pay out and sometimes this is over 100% of earnings because the companies are structured differently. But, this is a reason why book value can tread downwards for REITs (and, as it did for some income trust companies).

Some companies, when they are unsure if earnings will hold, give out special dividends when they can and only raise the dividends when they can make the rise permanent. Leon’s Furniture (TSX-LNF) is a company that does this.

We are in a secular bear market and have been since 2000. Until we get out of it, the market will not do much. That is why dividend paying stocks are a good place to be. They do not fall as much as the general market, but they also do not rise as much as the general market. However, you can make a decent return over time.

There are arguments that the Canadian market has gotten out of the secular bear market while the US is still in one. I do not personally believe this. Our market is doing better than the US market, but I do not think we have left the secular bear. (You can blog a lot on this topic alone.)

Do not forget that you can get cyclical bear and bull markets within secular bear and bulls markets. Secular bear and bulls markets generally last around 15, 16 years.

We will not get out of this secular market until we do something about the debt we are in. A lot of this will depend, no so much on Canada, but on the Americans because their economy can greatly affect ours. Our market has done better than the US ones since 2000.

Would anyone else like to answer this?

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