Both Sides Now
And no illusions!

by Ann Coleman
(TMF AnnC)

Reston, VA (April 21, 1999) -- We've looked at dividends from both sides now, so if you're thinking you really don't know dividends at all, let's see where they may fit into your investing plan.

One of the more persistent bits of conventional wisdom is that one should switch more to income-producing investments as one approaches retirement, and once in retirement, investments such as bonds are best.

As we discussed on Monday, dividends have the potential to provide a much greater source of stable income during retirement than bonds. My friend who was earning 30% per year in dividends on his Exxon (NYSE: XON) investment can certainly vouch for that. Tuesday we compared dividends to capital gains when taxes are part of the picture. Today, lets assume that your dividend-producing stocks are safely tucked away in an IRA, which treats gains from dividends and capital gains the same way. (How fair that is is a whole 'nother story -- maybe next week we'll take a look at it.)

I don't know when our friend make his fortuitous investment, but let's look at a similar scenario to see how dividends can help finance those annual eco-vacations you plan to take when you retire.

Suppose you had invested $10,000 in Exxon stock in January of 1980. The split-adjusted price for stock purchased at that time is around $2.50. The actual price was around $61, so you would have purchased around 160 shares of stock (remember, commissions were high back then) with your $10,000 investment. At that time, the company was paying an annual dividend of $4.80, which means the yield was around 7.9%. (Before you get excited at that level of yield, remember this is 1980 we are talking about. One year T-bills were paying 11%, and inflation was scaring people to death.)

Flash forward to today. Exxon has split 2:1 three times since 1980, so today you would own 1,280 shares (160 x 2 x 2 x 2). Exxon's current dividend is $1.64 per share. That's $2,099.20 per year on your 1,280 shares -- 21% of your initial investment is being returned to you each and every year. Even at the height of hyperinflation, reasonably safe bonds never offered that kind of interest rate.

[Before someone gets all excited and writes to me about how this proves the value of splits, let me just note that if Exxon had not split but had continued to pay out the same percentage of earnings per share in dividends, the dividend would be $13.12 per year. $13.20 x 160 shares is $2099.20.]

If you had put the same amount of money into bonds, even at the peak of hyperinflation, you would be making maybe half that, IF your bonds haven't been called. (Some bonds come with call provisions, which let the issuer weasel out of the deal -- ahem... refinance at a lower rate -- after a certain number of years.)

Now, you do the math: What are your Exxon shares worth today? What will your 20-year bonds be worth next year when they mature?

Answer: 1280 shares of Exxon are worth approximately $102,400. Your $10,000 worth of bonds will be worth $10,000 when they mature. (A word on bonds: 25- and 30-year bonds issued during the early '80s are actually worth quite a bit more than their face value today because of the high interest rate that they pay, but since the maturity date is getting close, the higher interest rate isn't as valuable as it was at one time. Bond traders made a lotof money on those bonds as interest rates came down. Trading bonds is a tricky game, though, and not recommended for the inexperienced.)

Initially, bonds would have paid a higher interest rate, but which one would have paid for more eco-vacations?

Friday: Yes, I know that I am talking about buying and holding. Friday we look at how the Foolish Four strategy and its annual turnover fits in here.

Fool on and prosper!

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Today's Stock Lists | 1999 Dow Returns

04/21/99 Close
Stock  Change   Last
CAT  +1  3/16  61.88
JPM  +2  7/8   141.50
MMM  +1        82.63
IP   -   5/16  53.44

                Day   Month    Year   History
      FOOL-4   +1.21%  23.33%  26.83%  28.71%
        DJIA     +1.27%   8.13%  15.63%  15.18%
        S&P 500  +2.29%   3.87%   9.01%   9.28%
        NASDAQ   +3.26%   1.08%  13.48%  15.04%

    Rec'd   #  Security     In At       Now    Change

 12/24/98   24 Caterpillar   43.08     61.88    43.63%
 12/24/98    9 JP Morgan    105.51    141.50    34.11%
 12/24/98   22 Int'l Paper   43.55     53.44    22.70%
 12/24/98   14 3M            73.57     82.63    12.31%

    Rec'd   #  Security     In At     Value    Change

 12/24/98   24 Caterpillar 1034.00   1485.00   $451.00
 12/24/98    9 JP Morgan    949.62   1273.50   $323.88
 12/24/98   22 Int'l Paper  958.12   1175.63   $217.51
 12/24/98   14 3M          1030.00   1156.75   $126.75

              Dividends Received      $29.45
                             Cash     $28.26
                            TOTAL   $5148.59