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Friday, October 10, 2008

You should be buying into the market right now

If you have a time horizon beyond like five years, you should be buying into the market right now.

First of all, there are two ways companies return earnings to shareholders, stock buy-backs and dividends. From an academic, non-behavioral point of view, they are the same. However, in bull markets, buybacks help the stock price more and in bear markets, dividends help more. That's tangential to the current argument, though. The main point is that some stocks pay dividends and any type of fund that holds them passes on those dividends. So, at any time, most every fund that holds stocks will throw off some income.

For a variety of reasons, companies are loathe to reduce their dividends. You want to really signal to the market that things are bad for your company? Reduce your dividend.

So, with the stock markets in open panic, your going to buy a pretty nice dividend yield. The yield on the S&P 500 was 2.38% on September 30. The market's declined something like 30% since then, so dividend yields are probably well over 3.0%. Furthermore, many companies that pay dividends are "safe" havens -- their financial performance is fairly constant across all economic environments. What I'm getting at is that in a panicky market, dividends are going to decline at a much slower rate than equity prices. Buying at just about any time during the panic will get you a decent dividend yield.

Let's say we find a bottom at a 50% market decline. Recovering all those losses in five years requires ~14% growth each year, right around historical norms (returns are geometric, not linear.) Let's be conservative and say you get 8.5%. Add in your 3% dividend yield. You've got 11.5% appreciation. Actually, if you reinvest the dividends, it's even better. The math is kind of complicated and path-dependent, so I'm going to leave that alone right now, though.

What if you time the bottom wrong? Let's say you get in at a 30% decline. With the 8.5% return, you're looking at about 1.5 years more to get your price back. Your dividend yield will be a few basis points lower. You still get double digit returns. You should still buy.

THIS IS THE BUYING OPPORTUNITY OF A LIFETIME! You can try to time the bottom, but it's already sweet enough for me.

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