Edited: Sideways Market Sound Bite

If stock prices remain steady and if valuations return to reasonable levels through earnings growth, the best stock allocation for dividend investors will be a toss up.

A dividend investor never sells any shares. He lives off the dividends. Almost always, dividend amounts grow faster than inflation.

At today’s prices, a dividend investor can (with care) get a 4% dividend yield. Assuming that his earnings growth matches the long term growth of the S&P500, his dividend growth will be 1% faster than inflation.

Many dividend investors start out with a lower yield and a better growth rate.

Dividend investors who also hold TIPS receive a steady 2.0%+ real return in the form of interest. Varying stock allocations changes little: 4% initially plus 1% real growth from dividends versus a steady 2% real return.

Computational Details

Today’s yield is 4.0% for dividend investors.

The growth rate for dividend investors is 1.0%.

Annualized Comparisons

The return from dividends, when annualized, matches the interest from TIPS at year 4. In this example, dividends have a higher annualized return prior to year 4 and a lower annualized return after year 4. Faster dividend growth rates, possibly at the cost of lower initial dividend yields, can delay this crossover point.

Recap

If stock prices remain steady and if valuations return to reasonable levels through earnings growth, the best stock allocation for dividend investors will be a toss up.

Dividend investors who own TIPS as well as stocks will do well if prices drop faster. They will be able to replace their TIPS with stocks at more attractive yields.

Have fun.

John Walter Russell
December 4, 2006