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Wed. Jan. 14, 2009

Dividend Stocks Role In The Future Recovery *

Dividend stocks are sometimes referred to as defensive stocks since many investors flee to them in an economic downturn. Their dividends, if sustainable, provide a minimum level of positive return. This cushions the downward pressure from the market. But what happens when the market turns up?

Beta is a quantitative measure of the volatility of a given security or portfolio relative to the overall market, usually the S&P 500. By definition, the market has a beta of 1.0 and securities are ranked according to how much they deviate from the market. Thus, securities with a beta above 1 are more volatile than the overall market, while those with a beta below 1 are less volatile. High-beta stocks are supposed to be riskier but provide a potential for higher returns, while low-beta stocks pose less risk but also lower returns.

Dividend stocks tend to have low betas. That means during a market downturn, they tend not to fall as much as the market in total. Hence, the term defensive stocks. It is also important to note that defensive stocks tend to be non-cyclical. Examples would include food, tobacco, oil, and utilities where demand is remains stable under difficult economic conditions. This was evidenced in my income stock’s 2008 return of -20.4% vs. the S&P 500 return of -36.3% (VFINX).

Here are some of my low beta holdings:

  • Chevron Corp (CVX): 5-yr Beta 0.67 (analysis)
  • Pepsico Inc (PEP): 5-yr Beta 0.58 (analysis)
  • Johnson and Johnson (JNJ): 5-yr Beta 0.49 (analysis)
  • Kimberly-Clark Corp (KMB): 5-yr Beta 0.40 (analysis)
  • Consolidated Edison Inc (ED): 5-yr Beta 0.25 (analysis)

This of coarse works against you when the market turns up. The low beta means the stocks don’t increase as fast as the market in an upturn. As a dividend investor, I should expect to under-perform the market during significant bull markets. I have selected certain higher beta stocks to mitigate this shortfall. However, as a dividend investor my goal is an ever-increase stream of dividend income, not to maximize total shareholder return.

Full Disclosure: Long CVX, PEP, JNJ, KMB, ED, VFINX


11 Responses to “Dividend Stocks Role In The Future Recovery *”

  1. Pinyo says:

    Good explanation of beta and the defensive role of dividend stocks. I have a dividend ETF in one of my account just for this reason.

  2. Dividend Growth Investor says:

    I am not a big believer of dividend etfs versus investing in dividend growth stocks on your own. The reason is that many etf’s focusing on dividends could hold on to high yielding stocks which have cut dividends; or just chase highr yields and sell covered calls, or participate in complex dividend arbitrage strategies.
    Other reasons why I don’t like dividend etfs is that they are not very diversified sectorwise and most of them are structured to chase high current yield by overweighting higher yielders at the expense of lower yielders.
    Last but not least, not all stocks in an etf are bargains at all times.

  3. Niklas Smith says:

    If most of stockmarket returns come from reinvesting dividends rather than capital growth of shares (Barclays Equity-Gilt Study – true of the UK at least) then surely dividend shares are likely to beat the market except in bubbles (e.g. Dotcom boom), assuming dividends are reinvested?

  4. Dividends4Life says:

    Niklas: You are correct that dividend reinvestment is paramount in achieving superior long-term returns. When I said “significant bull markets”, I had the DotCom bubble in mind.

    Best Wishes,
    D4L

  5. crawdaddy says:

    First off, I want to say that I love your site! dividends4life is such a great resource. Thank you for sharing all your great knowledge and analysis. I was wondering if you knew of any good Dividend investing sites/blogs that focus on Canadian dividend stocks. Thanks again

  6. Chris says:

    I have a question. Why does it seem Canadians love dividends so much? I love them too, but there seems to be many Canadian dividend sites, and many readers are Canadian. Is there a large difference in taxation north of the border?

  7. Dividends4Life says:

    Crawdaddy: Here are several Dividend blogs run by Canadians:

    http://www.thedividendguyblog.com/
    http://themoneygardener.blogspot.com/
    http://www.nurseb911.com/
    http://dividendmoney.com/
    http://www.traderscorner.ca/blog/2

    Chris: I had the same question. Here is a link to the answer:

    Canadian Connection

    Best Wishes,
    D4L

  8. Question for the dividend lovers, what is the back-up plan if the economy worsens and the traditional dividend stocks cut it to 0 in order to save capital?

    I’m not hating as I do believe in dividends, but y’all are the experts and I wanted to get your thoughts.

  9. the weakonomist: If all traditional dividend companies take their dividend to zero, we have bigger problems than worrying about dividend income.

    Best Wishes,
    D4L

  10. VC says:

    What do you think about investing in companies that usually are cyclical but just have been beaten down so much they have high yields. For example GE, has over a 10 percent yield. This stock has already been beaten down so much it probably will not go much lower. This way you get the nice high dividend stock with low risk. But at the same time, when the economy picks up, GE is cyclical so it will go up more than a “defensive” stock. This stock won’t work against you in a bull market. Best of both worlds?

  11. VC: I am not convinced that GE’s dividend will survive. By rule, when a company freezes it dividend, put it “on the shelf” until its dividend policy is clear.

    Best Wishes,
    D4L