I Still Hate Dividends, Professor Siegel

Wharton Professor Jeremy Siegel is much revered. His students sing his praise, his books are best sellers, the press adores him. I’ve heard him speak and he is very engaging, even convincing. He is also totally wrong. About dividends. About ETFs based on dividends. Enough to lose you money.

A few years back I wrote an op-ed for the Wall Street Journal Op-Ed page about dividends. Specifically, that I hate dividends. You can read it here. Stocks trade on their prospects for earnings. Dividends are just a bribe to get you interested in slow growing companies who can’t be bothered to reinvest their earnings in something useful. In the past, when companies paid out 100% of their earnings to shareholders, well then dividends mattered. Today, no one pays 100%, so dividends have limited say in the value of a company. In fact, they sucker you in with attractive “yields” right before they consider cutting the dividend. Citigroup anyone?

as persuasive as arguments may sound, the hard evidence proves otherwise.

Sadly, to academics such as Professor Siegel, this is heresy. He was nice enough to write a letter to the editor about my piece saying that I was completely wrong. He is entitled to his opinion, of course, as I am entitled to hold a grudge. He even took a swipe at me in his March 2005 book, The Future for Investors: Why the Tried and the True Triumph Over the Bold and the New, (although he called me Arthur Kessler, nice fact checking, Professor Seagull). And I quote,

“As persuasive as Kessler’s arguments may sound, the hard evidence proves otherwise…Average returns on older firms surpassed the returns on the newer firms…Technology stocks, which pay the lowest dividends have scarcely been market beaters.”

Like, say, Apple. Don’t bother with the book, it is backwards looking twaddle.

Since then, Professor Siegel has ventured outside of academics into the real world, helping endorse (for equity) Wisdom Tree, a family of ETFs based on his research that dividend-paying companies outperform the market. He claims he backtested his dividend algorithms and they are sure-fire winners. Hedge fund legend Michael Steinhardt also apparently back tested the algorithms and put up capital to fund WisdomTree Asset Management Inc. So did some friends of mine at RRE Investors (shh, don’t tell them I am writing this). It has been a decent investment. According to this great piece in Forbes on Jonathon Steinberg, they now have close to $5 billion in assets. Unfortunately for investors in their dividend funds, Siegel’s premise that dividend-paying stocks will outperform the market as a whole is flawed.

Here is the description of the WisdomTree Dividend Index:

A fundamentally-weighted index that defines the dividend-paying portion of the U.S. stock market. The Index measures the performance of US companies…that pay regular cash dividends….The index is dividend weighted…to reflect the proportionate share of the aggregate cash dividends each component company is projected to pay in the coming year…

So let’s see how Professor Siegel’s algorithms did in 2007, the first full year of operation. Not so good. 2007 is a year that the S&P 500 index, “The Market” by most people’s definition, gained 3.53%. Talk about a low hurdle. Widsom Tree domestic dividend funds all underperformed. Which is as kind as I can put it.

The LargeCap Dividend fund, DLN, which charged you 28 basis points for the privilege, opened 2007 at $56.64 and closed (adjusted for dividends and splits, according to Yahoo Finance) at $57.76. That’s a gain of 1.98% or almost 150 basis points below the S&P 500 index (and I'm being nice, the S&P was up 5.49% with dividends reinvested in 2007). Ouch. That would get most managers fired. And that was the BEST of the domestic funds. They all sucked wind, and four out of six lost money, as seen in the chart below.

                                                               

Wisdom Tree ETFs	01/01/07	12/31/07	Return
LargeCap Dividend	56.64	57.76	1.98%
Total Dividend	56.39	56.75	0.64%
Dividend Top 100	56.57	56.22	-0.62%
High-Yielding Equity	56.07	53.14	-5.23%
MidCap Dividend	55.55	52.02	-6.35%
SmallCap Dividend	55.65	48.53	-12.79%
S&P 500	1,418.30	1,468.36	3.53%

Wisdom Tree smartly diversified and created International Dividend Funds and then funds that were indexed based on earnings (now there’s an idea) and then some that mimic, well, other traditional cap weighted indexes. Some of these are doing just fine. And maybe the dividend funds will do well in 2008 (though I doubt it).

As Professor Siegel himself might say, as persuasive as dividend arguments may sound, the hard evidence proves otherwise.

 

Comments

[Blackswan]

Mr. Kessler, my hat is off to you. You've got Prof. Siegal exactly right-the teflon academic, and it's about time Wall Street and the financial media take a closer look at this man and his record. I have been a subscriber to his weekly letter-and have the bruises to prove it. In the October 5th letter he put out a very bullish call on the financials, specifically the banks. You'll recall that is literally days before these stocks then collapsed. Since then he has bullishly updated that call twice-of course, for the long run. Well, by acting on his advice I estimate it will take two years, if I'm lucky, to get even by following this permabull's advice that has to be one of the worst calls in history-and the media doesn't notice, let alone call him to task.

[Gerg]

That's just one year's results. Surely it just means that this past year the market rotated out of cyclical industrials into growth tech stocks. Anyone who makes investing decisions based on one-year results is just being silly.

[Gerg]

Also your "You can read it here" link is a 404 error.

[Paul]

I think your S&P 500 return fails to include dividends paid during 2007 which raises the total return to 5.48% for calendar year 2007. The DLN returned 2.48% including dividends for 2007. Both according to Bloomberg.

[Barry Ritholtz]

I like Prof Siegel personally -- he is a gentleman and a scholar -- but I have been in total disagreement with him on everything else.

The major problem with looking at just dividends, which are earnings reliant -- is the cyclicallity of the earnings themselves. The Financials had great earnings, because early in the cycle they ignored risk. (Same for the Home Builders) When that risk embracing approach came up snake eyes, the earnings (and dividends) took a giant hit.

So much for the dividend basis for investing . . .

[Jan]

I have to say that I'm on the dividend side of this particular fence. Any SERIOUS dividend investor checks the sustainability of the dividend, before pulling the trigger. Recently, I read a quote by somebody to the effect "More money has been lost chasing yield, than has been lost at the point of a gun", and I'd be inclined to agree. Top down sector analysis, followed by bottom up company analysis will keep one from making any truly huge mistakes.

Jan

[Drake McHugh]

Good catch Andy. When Mr. Siegel started floggin value investing in August of 2006, I knew the macro trend back to favoring growth stocks was about to occur. Seigel had worked for various money managers implying a tacit recommendation for years. Capitalism is great and really great to see an academic go out and actually try to work for a living. I guess my concern is that his imprimatur as an academic intellectual is a bit of a ruse as the true role is promoter extraordinaire. A little more disclosure of his conflict of interest would be helpful....... after all - we all know there would be no interest if there wasn;t a conflict of interest - cheers-

[Danny]

I guess you missed that one book, Stocks for (READ:) the Long Run.
Only time will tell with the returns of the Wisdom Tree funds. Evaluating a value fund's performance off it's first year is just naive.
And I guess someone already caught you on misstating the S&P 500's return for 2007...i would think that would be something basic.

[RB]

One comment said "Anyone who makes investing decisions based on one-year results is just being silly."

I'd use stronger language than "silly" if I were allowed here. It would probably be deleted!
This article is MEANINGLESS because of the short term figures and thinking.

Another comment said "by acting on his advice I estimate it will take two years, if I'm lucky, to get even"
Oh, well, if you are a short term trader, do that. Don't follow long term advice if you are going to care about 2 years. I'm LOVING my bank purchases over these past months! I'll collect juicy yielding dividends and FIVE TO TWENTY years from now I'm not going to care about the short term you guys are so concerned about.

So how wrong is Siegel really? You are short term thinkers and he is long term. So the comparison is bogus. Would you write an article comparing the taste of a companies beef to another companies tofu and say the beef people are wrong? : )

RB

[DM]

I just heard a rumor that Steve Cohen is laying off 90% of the staff at SAC because investment decisions based anything less than one year are just silly. Word has it he plans to launch an alpha investment dividend strategy ETF under the ticker "AIDS". Oh, and if that wasn't exciting enough, AIDS will be "elevated" to the power of Red too!!! .00005 bps of the investment management fee will go towards...? It's a dream come true...dividend stocks compounding Red times every YEAR! Tell your friends!

Safety of the dividend? I believe that requires a value judgment to be made. Apparently, the sage quants at Wisdom Tree aren't very good "dividend stock pickers" than.

It's f'ing marketing. Seriously, save the maxims. Every strategy has seasons and dividend strategies are no different. Got Dogs of the DOW?

When is the street going to give me the structured product I really want...a leveraged long against the "dumb investor index". With the cooperation of Tony Soprano it should be an easy product to hedge long deltas.

Andy, thanks for your contributions with entertaining delivery.

DM