Edited Dividends and the Gordon Model

Dividend yields vary all over the place because prices vary. Prices depend upon current human perceptions. Dividend amounts are stable. Dividend amounts depend upon business activity.

A retiree can reasonably expect to see his initial dividend amount grow by 2.8% each year in addition to inflation.

Mathematical Derivation

Although the mathematical derivation assumes the very long-term, the Gordon Model turns out to be most accurate between 5 and 15 years. The reason is that returns of reinvested dividends are often different from initial returns.

Time and the Gordon Model

From the Gordon Equation, the initial dividend yield plus the dividend growth rate plus the Speculative Return equals the Total Return. In the very long-term, the Speculative Return becomes smaller and smaller. In the very long-term, stocks have delivered a 6.5% real, annualized, total return. When I enter P/E10=13.8, the Stock-Return Predictor calculates a Most Likely return of 6.50%.

This allows us to normalize yields.
..
Solving: the dividend growth rate = 2.8% per year, real, annualized.

The Stock-Return Predictor

There is an apparent conflict with the Stock-Return Predictor. The explanation is straightforward: Reinvested dividends will buy many more shares at lower prices.

Retirement Planning

A retiree can reasonably expect to see his initial dividend amount grow by 2.8% each year in addition to inflation. The failure mechanism (dividend cuts) is gentle. Provided that he invests in high quality companies at reasonable payout ratios, he can plan on a downside risk of only 10% (20% worst case) with full recovery within 5 years.

This number (2.8% per year, real) allows you to determine the right amount to boost your income via a liquidating TIPS ladder during the earliest years of retirement.

Have fun.

John Walter Russell
January 17, 2007