Falling Dividends Mean Bonds Pay More than Stocks

I like high dividend stocks because they offer a stable source of income and a low tax rate. Right now, dividends are in the cross hairs of many companies looking to save cash, and that doesn't bode well for equities.

Ask most casual investors, and they'll tell you that they buy stocks for the appreciation. But dividends account for 70% of after tax income since 1900 after inflation. So when dividends get cut, equities don't look nearly as attractive as bonds. According to a Bloomberg article:

"U.S. equities returned 6 percent a year on average since 1900, inflation-adjusted data compiled by the London Business School and Credit Suisse Group AG show. Take away dividends and the annual gain drops to 1.7 percent, compared with 2.1 percent for long-term Treasury bonds, according to the data.

A total of 288 companies cut or suspended payouts last quarter, the most since Standard & Poor’s records began 54 years ago, when Dwight D. Eisenhower was president. While the S&P 500 is trading at the lowest price relative to earnings since 1985 and all 10 Wall Street strategists tracked by Bloomberg forecast a rally this year, predictions based on dividends show shares are overvalued by as much as 46 percent."

Companies are cutting dividends like never before and that's bad news for the market and for equity investors.

The dividend discount model established by Myron Gordon estimates that the S&P would have to fall to 526 before investors are compensated for adequantly for owning shares.

Two companies that aren't expected to cut their dividend are McDonald's and P&G. According to the model, McDonald's stock is undervalued by 46% and P&G is undervalued by 42%.

As companies slash the cash they pay out to shareholders, it makes sense that companies that maintain dividends will see a premium built into their stock price.

This chart shows the dividend yields of the 30 members of the Dow Jones Average.