The two worlds theory

I’ve received a lot of questions lately about equity yields and their relation to valuation. I would urge dividend investors and those who might be concerned about the equity market’s current valuation to not rely, even slightly, on the S&P 500’s current dividend yield as a measure of valuation or future direction. The index’s roughly 1.1% yield is now for all intents and purposes the same as it was in 2000 at the height of the Internet Bubble. I believe dividend investors should ignore that fact. The market may be undervalued, it may be overvalued, it may be porridge-perfect—but dividend yield has nothing to do with it.  

Once upon a time, in a world far away, dividend yield was a useful tool for measuring the broad market (via the S&P 500, created in 1957). By the mid-1990s, dividend yield was already largely irrelevant as an aggregate measure. Investors drove up and rode down internet stocks in the late 1990s without regard to yield at the security or index level. The market’s record-low dividend yield at the time was a coincidental factor, not a causal relation that might explain or forecast market movements. I believe investors should assume the same now.

My team and I continue to value securities and portfolios based on dividend yield and dividend growth potential, trying to achieve optimal returns for investors. But of necessity, with the weighted opportunity set registering just 1% yield, we operate only in selected sectors and are noticeably absent in others.

With the S&P 500 yielding so little, dividend investors operate in a parallel world. We are not necessarily in combat with, but certainly not in conjunction with, the broad market. It’s been that way for more than 30 years. The current frisson of enthusiasm is just one more instance of a story that I believe will eventually come to an end.

In my book The Ownership Dividend, I forecast a return to the “cash nexus,” in which minority shareholders in successful publicly traded businesses insist on cash returns for their cash outlays, even for tech companies. For now, that claim is early, perhaps very early. At present, other factors are driving investment decision making. Until a long-term investing mean reversion occurs, I’ve got my popcorn ready, and I’m keenly tracking the market adventure. I’m not clutching my dividend pearls. 

The Ownership Dividend: The Coming Paradigm Shift in the U.S. Stock Market was published by Routledge in 2024.