The S&P 500 and Its Dividends

Here’s an update of a chart of the S&P 500 and its dividends. The S&P 500 is the blue line and it follows the left scale. The dividends are in red and they follow the right scale. I scaled the two axes at a ratio of 50-to-1. This means that anytime the lines cross, the dividend yield is exactly 2%.

I wouldn’t place the market’s dividend yield as one of my top valuation variables, but it’s still worth looking at the market’s relationship to its dividend payouts. First, there’s a purity to dividends. You never really know what a company’s cash flow or earnings are. But if a company is willing to part with money, then you know it’s real.

I also like how stable dividends are. That really stands out in this chart. While the market had frenetic rallies and plunges, the dividends are fairly steady.

By looking at dividends, you can see how the market went from being very underpriced in the early 1990s to wildly overpriced by the late 1990s. There are a few lessons. I think there was a secular lowering of dividends up to 2000. As recently as 20 years ago, the market’s dividend was at 4%. That’s unthinkable today. By the time the bubble peaked in 2000, the overall yield was close to 1%. Even after the air came out of the bubble, the yield barely hit 2% (see how the lines touched in late 2002).

I think it’s also interesting that the market’s rally from 2003 to 2007 basically mirrored the rise in dividends. There was a bubble in housing and other sectors, but general stock valuations were well within historical context.

The drop in dividends after 2007 is overstated thanks to the dramatic cutting of dividends in financial companies. We’re probably going to see many dividend increases this year. JPMorgan Chase (JPM), for example, can easily triple its dividend without breaking a sweat.

Even with the big drop in dividends, it’s dwarfed by the plunge in stock prices. I think it’s likely the 2% will be the New Normal for dividends.

Posted by on January 11th, 2011 at 12:16 pm

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