Sunday, January 11, 2009

SPX Dividends, EPS, & Yield

I've made reference to SPX yields more than once since I've started writing this blog. It's a little more difficult to tackle because I rarely see (or at least haven't found) any "dividend estimates" in the same way that there are earnings estimates. This post will hopefully go some ways to providing context about dividends and yields historically as well as possibly addressing the questions that immediately pop out at me when I look at the chart of quarterly earnings and dividends to the right.

First, why haven't dividends fallen further when both operating (oEPS) and as reported (arEPS) earnings have declined significantly? And second, how far could they fall in the quarters ahead?

The data for this analysis comes from both Shiller and S&P. Shiller's historic data uses "as reported" earnings and S&P provides the operating earnings going back to 1988. When the chart is examined the steady and basically regular growth of dividends from 1962 through about 2000 is fairly remarkable. Then, things start to get a little hairy before resuming a rapid rise to a peak in Q4/07.

So what about the periods of earnings declines and their impacts on dividends?
There are several periods of considerable as reported earnings drops: most are obvious from the chart but also 2H/74 to Q1/75, Q4/81 to Q1/83. Looking at peaks in arEPS during these times, the average fall was about -45%. Interestingly, during these periods dividends were on average flat though this owes to the 1989 period when dividends somehow grew by 14.4%.

That being said, SPX dividends actually peaked in Q4/07 at 7.62, one quarter after earnings had peaked before beginning their current slide. Adding to this odd behavior is that dividends went up from Q3 to Q4 by 10.4% even as oEPS fell by -27% and arEPS slid -48%. Huh. Color me confused. At any rate, dividends are now off a bit over -6% from that peak. So how does this rate from a historical perspective in terms of yield?

Average yield of SPX since 1962 has been 3.13% and the current level with the dividends from this quarter is roughly 3.19%. Just for reference, during that period the 10-year treasury has averaged 6.95% and the average difference between SPX yield and the 10-year has been -3.83%. Currently, that difference is 0.80% and this seems to be the only time between 1962 and today that SPX has yielded higher than the 10-year. So... is SPX cheap?

From one measure - difference between 10-year Treasury yields and SPX yield - I guess so. But like everything else, this depends on some significant assumptions. First, that the Treasury yield will not begin rising (see earlier post for Federal debt requirements in 2009) and that SPX dividends will at least move along with any run up in SPX. From the basic historical average of SPX yield however, this doesn't really mark anything but a return to the average. And it also hinges on the assumption that earnings do not deteriorate further, at least in the near term. The chart to the right shows the 10-year vs SPX yields since 1962. Unfortunately, it would appear that the dramatic decline in SPX is more responsible for the climb in yields than increasing dividends. Or rather more accurately, dividends have not fallen nearly as much as the index (or EPS!).

Thus far the context has been filled in, more or less. Considering how wildly off the estimates for S&P EPS have been in the past quarters, the notion that they now have a firm grip on EPS going forward is umm... naive. Maybe wishful thinking, whatever. Let's assume though that EPS stabilizes at this current level which is approximately in the area of mid-2004 and perhaps increases at a modest rate similar to what I posited back in an earlier post. The 4.1% growth in oEPS would bring this metric up to roughly December 2005 levels by Q4/2009. Dividends at that time were about -15% lower than the current quarter. So if EPS grows at that slower rate, how much cash is available from the balance sheets of the S&P 500 to fund dividends? My guess is not nearly as much as there was before this whole debacle really got started. (I really need to go through the Fed's Flow of Funds report more closely to see if I can find some more data.)

Take what you will from this pile of information. I would not bank on the current level of dividends being sustainable through 2009 without some serious uptick in EPS which I honestly don't expect. Unless I have severely underestimated the stomach of corporations to seriously weaken their balance sheets in a vain attempt to boost share prices, it just doesn't seem possible. What SPX does between 12/31/2009 and today is anyone's guess, but I am expecting to hear about further dividend slashes coming up that will push SPX yield down in the next quarters.

Here's one other of my 2 cent ideas: When you look back at Shiller's entire data set, it looks like there was actually a time when people invested in the S&P for the yield paid rather than sheer capital gains alone. Might the market emerge on the back of that same model? It could make some sense and provide some level of confidence back to the market players.