Dividends are Especially Important in a Bear Market

This is the lost decade.  Since the end of 1999, stocks have declined 15 percent; including reinvested dividends, the total return is slightly ahead.  Motley Fool observed that from 1980-2005, while the S&P 500 surged from around 100 to 1250, dividend stocks out-gained non-dividend equities by more than 2.6 percentage points a year.

Dividends represent defensive protection, a dire necessity during this bear market.  Curiously, they somehow are being neglected in this market tumult when all the attention seems to be focused on bottom fishing, catching a falling safe, or finding the rare sectors that might escape the downdraft.

There is a tendency to neglect dividends during bull markets as in the 1990s.  Even then you forgo dividends at your own peril.  Astonishingly, dividend-paying stocks outperform non-payers, even in bull markets. 

A study by Arnott and Assness shows a direct positive correlation between dividend payout ratios and earnings growth - the higher the payout, the faster the earnings pace.  From 1920-2006, as found by the Motley Fool Income Investor, some 41 percent of total stock market returns stemmed from dividends.  That's a lot to leave on the table if you are focused only on growth stocks. 

I practice what I preach.  Plains All American Pipeline (NYSE: PAA) has a dividend yield of 7.5 percent.  During the last six months the stock has held firm.  Including the dividends, my overall return is more than 5 percent.  Diana Shipping (NYSE: DSX) has a stellar yield of more than 12 percent.  Over the same span the shares have fallen 8 percent.  Adding back the dividend, the decline is just 3 percent, better than the overall stock market.

In my book, Full of Bull, I stress the importance of dividends as one of the five most critical keys to successful investing (the others being preservation of capital, owning only a modest number of stocks, focusing on value stocks and holding stocks long-term).  Lately, however, some firms such as banks and financials have been cutting their dividends, casting all dividends in a bad light.  You need to own stocks that have steady, reliable, solid earnings underpinning the dividends. 

Don't lose sight of the paramount importance of dividends.  They will help you protect your capital during this bear market.

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