Posted on 05/14/2006 9:48:40 AM PDT by BenLurkin
I don't know when we'll see the next bear market. But like you, I know it's coming ... it's not a matter of "if" but rather a matter of "when." And today I'll tell you how you can prepare your portfolio so that you'll not only survive the bear intact, but also be better off than if it never happened at all.
Siegel says We had the pleasure of hearing one of the world's great investing minds deliver the keynote speech at a recent Fool investing seminar. Wharton professor Jeremy Siegel is well-known for his book Stocks for the Long Run, and his latest -- The Future for Investors -- is another classic. In this book, Siegel lays out the secret for successful investing through all market cycles, and it's in complete agreement with what Mathew Emmert teaches in the Motley Fool Income Investor newsletter.
It all boils down to the incredible importance of owning dividend-paying stocks and of reinvesting those dividends. It's a concept I wrote about last fall in The Greatest Investing "Secret." Today, I want to expand on this by showing how bear markets can actually help your returns.
Dividend-paying stocks act, in Siegel's words, as "bear-market protectors" and "return accelerators" during down markets:
Dividend yield is a huge factor when it comes to actual returns. The yield is simply the dividend per share, divided by the price. So a $100 stock that pays $2 in yearly dividends has a yield of 2%. When stock prices fall, yields obviously rise as long as companies don't cut their dividends at a greater rate than the price drop. When those dividends are reinvested, they purchase more and more shares at lower prices during a bear market. These extra shares act as a bear-market protector. Then, when share prices reverse, the extra shares act as a return accelerator and rocket total returns higher. Beating the Depression The greatest example of how all this works involves the stock market crash of 1929 and the Great Depression that followed soon after. On Sept. 3, 1929, the Dow Jones Industrial Average hit 381 -- and it did not reach that level again until November 1954. That's an incredible rough patch that pained investors for a full 25 years.
As I pointed out in my previous article, Siegel explained the surprising truth that the average stockholder who reinvested dividends actually showed a positive return of more than 6% per year during that 25-year period, easily beating the performance of bonds and short-term treasuries. Think about that the next time you hear someone say it took 25 years for stock investors to break even during that period. That's true only for those who didn't reinvest their dividends!
Siegel has additional (and surprising) revelations:
If the Great Depression had never occurred, and if dividends had made a smooth ascent while stock prices remained stable, things would actually have been far worse for long-term stock investors. That's because $1,000 invested at the beginning of this fictional, stable period would have turned into only $2,720 by November 1954. That's 60% less than what dividend reinvestors actually accumulated in real life.
A dividend-paying stock that falls will recover its total value even if the price never recovers, and that's because of the extra shares purchased (bear market protector). In fact, the greater the fall, the fewer the number of years it takes to reach break even status. And, of course, if the price recovers, the gains are magnified because of the extra shares (return accelerator). Thus you can see that periodic bear markets are actually very beneficial to long-term dividend reinvestors. Siegel illustrated this with a case study of Philip Morris (now Altria Group (NYSE: MO)). Because of bad publicity and lawsuits, the cigarette maker's price was the same in March 2003 as it was 12 years before. Yet those who reinvested their dividends earned an average of 7.1% per year throughout that period. Then, when the stock price recovered, reinvestors had twice the number of shares than they had 12 years before.
Good for bulls, too Finally, to convince you that owning strong dividend-paying companies is a no-brainer, these stocks perform well across all market cycles. Consider that the 20 best-performing survivor stocks from the original S&P 500 in 1957 are all dividend-payers. Here is a small sampling of these "corporate El Dorados," as Siegel calls them, and their returns during his 1957 to 2003 study period (dividends reinvested, of course):
Philip Morris 4.07% 19.75% $4,626,402
Tootsie Roll (NYSE: TR) 2.44% 16.11% $1,090,955
Merck (NYSE: MRK) 2.37% 15.90% $1,003,410
Crane (NYSE: CR) 3.62% 15.14% $736,796
Fortune Brands (NYSE: FO) 5.31% 14.55% $580,025
Procter & Gamble (NYSE: PG) 2.75% 14.26% $513,752
Royal Dutch Petroleum (NYSE: RDS-A) 5.24% 13.64% $398,837
S&P 500 3.27% 10.85% $124,486
Source: Jeremy Siegel, The Future for Investors.
Foolish bottom line Siegel sums it up nicely: "Bear markets are not only painful episodes that investors must endure; they are also an integral reason why investors who reinvest dividends experience sharply higher returns."
This is the essence of what Mathew searches for every day in Income Investor -- stable dividend-payers designed to weather any market cycle. If you'd like to try out the service and get the full list of his market-beating recommendations, you can do so free for 30 days. There's no obligation to subscribe.
This article was originally published March 14, 2006. It has been updated.
Rex Moore is no relation to Rex Kwan Do in Napoleon Dynamite. He owns no companies mentioned in this article. Merck is an Income Investor recommendation. The Motley Fool is investors helping investors.
Dividends is good!!!
If I like the stock at $25 I will love it at $18. By dollar cost averaging and reinvesting the quarterly payouts I have realized a better return. Dividend stocks and funds are the best long term equity vehicle for investors.
Does this factor scare anyone else for the economy, housing, markets, wars, etc.? Would love to hear thoughts?
Disclaimer: The idea of China and the Olympic thing is not my idea, someone else on FR mentioned it but it has gnawed at me for a long time and seemed very relevant. Hat tip to ? for being so forward looking.
Much weight is placed on the period following the 1929 crash. During much of that period stocks yielded more than bonds and it was only during that latter stages of that period that stock yields fell below bond yields so it is not surprising that stocks outperformed bonds.
If the US economy goes into recession then China has a real problem on its hands. Demand for goods produced in China will fall and since they are in hypergrowth mode their economy will crash. Should that happen they run the risk of widespread domestic unrest which will certainly keep the leadership awake at night.
Interesting read about the Wharton/Enron connection:
http://www.gladwell.com/2002/2002_07_22_a_talent.htm
Talk about cherry-picking statistics. There were three bull markets during the 1930s. No investor worth their salt just buys and sits on it. Plus there weren't any DOW 30 stock funds back in 1929. The rest of this article is completely ridiculous.
Not a word about gold. Good. The "stealth bull market" will see $1000 gold well before anybody but gold bugs starts really paying attention.
Keeping the Bush tax cuts on dividends is the best thing for investors. It encourages long term investments in stable stocks. I'd like to see the same tax rate for interest earned on bank accounts and CDs as well. We can be a nation of savers if we are given some tax breaks.
The capital gains tax cut was good too. It caused people to take long term gains on property and stock that they held long and didn't want to sell due to taxes on gains. When the sales take place the money is freed up for new investments or opportunities. High taxes hold back growth.
Gold is only good in crisis investing. Long term the price doesn't rise and the storage costs cut gains.
It and silver are not a scarce as one may think. When the price gets real high, the gold jewelry wearers in India and other places cash out and suddenly there is a lot on the market.
Some say gold is headed to $1650. You do not have to buy gold (or silver) buillion to invest in in. ETF's (Exchange Traded Funds): GLD and SLV are the same as holding the metals. If you pull the chart, you will notice in this market correction the last few days, while almost everything else went down (including the high-flying mining stocks), GLD still went up slightly.
All precious metals, gold, silver, copper, titanium, uranium, etc., are in a supply/demand pinch and are rising and will likely continue. Gold is a hedge against inflation and the deterioration of the dollar, which is in decline against other currencies due to runaway spending & debt by the US guv-mint.
I am also starting to invest in Canadian Income closed end funds, which yield 8 to 11%, and are rising slightly in value, plus the US dollar is in decline against the Canadian dollar, so you gain a little bit two ways on your investment, plus the income.
To each his own.
When boomers start cashing in money for retirement the funds will come from tax deferred 401Ks. They will be paying their own social security "benefits".
True. The US government has coined millions of silver eagles in the last twenty years, "using up" its surplus stockpiles. But those coins are all still around, and will come out of the woodwork when the price is right, not to mention Aunt Minnie's sterling tea service that survived the last silver spike. Of course, the "right price" might be $50 an ounce like it was before. Or, if the rumors are true about a looming need for massive short covering, it might be $100 an ounce...might be.
Thanks for your thoughts.
The more the price rises, the worse it is for the shorts... then... the more the price rises!
Luv it.
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