Is the Dow Hot or Cold?

12/22/2011 1:03 pm EST

Focus: MARKETS

Kelley Wright

Managing Editor, Investment Quality Trends

Investment Quality Trends’ Kelley Wright shares his outlook for stocks going into the end of the year, and what the dividend yield theory is telling him about the market.

Kelley, what are your thoughts here on the overall market as you see it here going into the end of the year?

Through the end of the year, through 2011? Well, take your pick. I mean, we could be down 1,500 points in two weeks. We could be up 500 points. It’s still pretty volatile.

What we do is we measure dividend yield. The Dow Jones Industrial Average is right now going through a pattern where it trades between a 4% yield where it offers really good value, and a 2% yield where…not so much. You’re kind of getting into thin air there.

We’re kind of in an area where there’s about a 2.728% dividend yield on the Dow. In other words, we’re kind of right smack in the middle there. It’s not too hot, it’s not too cold, it’s just sort of in the middle. So we’re not getting a lot from that indicator there, are we going to go up, are we going to go down.

Does that mean that it’s an individual stock picker’s market, or are you going to be more careful there?

No question, no question about it. We’re not getting a lot of clues from the broad markets. So you look for individual value plays.

That’s really what we do is we look at stocks on an individual basis. If they offer value on a historic basis, then we buy them and we hold them and we wait for that value to be expressed. It doesn’t matter what is going to go on in the market up and down and all around, but that’s how we do it.

What does typically the presidential election year look like for you? Do you have any historical data there?

You know…a little bit. If you go back and you look at it, there is a tendency—I don’t know why or what—but there is a tendency for the third year in a president’s term, look at the math and the market has gone up, so we’ll see.

And next year, the 2012 elections, does that bear at all in mind in terms of the decisions you’ll be making next year?

Not really, we want to do one thing. We want a return on investment and we want to protect our principal, which is kind of weird for stock pickers—I kind of sound like a bond guy.

Preservation of principal, immediate return on investment, and then we harvest our gains when appropriate. Appropriate for us is when a stock has reached the upper end of its price range and its dividend yield has declined to really where it’s not attractive anymore.

That’s not really going to change for us. We’re going to do what we’ve always done, which is we’re going to look for value where it exists. We take what the market gives us, we grab it, we just wait—it will be fully expressed at some point, and then you hold on for the ride.

Where does the idea of the dividend yield being the good judge of value, is that an older theory or is this something new you’ve talked about?

No, it’s called the dividend yield theory. It was established a long time ago. It was kind of taken from some writing of Charles Henry Dow and Benjamin Graham, and that’s really where it comes from.

In its simplest form, what the dividend yield theory says is that everything you really need to know about a stock can be ascertained in its cash dividend and its dividend trend.

If you’re going to be invested in stocks, there are two ways that you’re going to make money. One is capital appreciation and one is the dividend. A dividend is a policy, it is declared by the board of directors. It has an X date, it has a pay date, and it has a record date.

Capital appreciation is not a policy—there is no X date, record date, or pay date on capital appreciation, and so a board of directors that makes a declaration of that type, this is a policy of our company; we’re going to share this percentage of our revenues of our profits with our shareholders. That’s something they’re establishing because they know probably far better than anyone else what the prospects for their company are.

That’s why we look at dividends, because it shows your company is profitable, and if the dividend is going up your earnings are rising. It shows confidence in the company by management. It’s a predictor of price movement, and it also provides a floor of safety underneath the price. That’s really the straw that stirs our drinks, because there is a lot of predictability and consistency in there.

I would imagine this would appeal a lot to somebody who really wants to simplify their investing down to a number that they feel confident. This is the thing that will help me find good investments in the market, they don’t have to worry about a lot of other technical analysis or fundamentals or worry about what the Fed is doing, and they can look at one thing.

We have found that the most folks are passionate about something, and it’s rarely the stock market. They’re doing what their passion is on a daily basis. They want to make money and they want to make it consistently over the long term.

What we have found is that this is a way for folks that want to own stocks, and they want to have capital appreciation and dividend income, that this is the best way in our mind and in our experience for them to identify value and to take advantage of the opportunities in the market.

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