S&P500 Dividend Design Baseline

I recently investigated S&P500 dividends to establish a baseline.

The S&P500 dividend amount has grown steadily at 5.5% per year (nominal, without adjusting for inflation) from 1940 to 2007.

Today’s dividends are safe. Any drop will be shallow, around 4% to 6%. The worst case 25% drop in real dividend income since 1950 was the after effect of inflation.

Using the single year payout ratio D/E is a poor predictor of dividend safety. Benjamin Graham’s use of smoothed earnings (as adapted by Professor Robert Shiller) is much, much better. Divide the current dividend amount by the average of the previous ten years of earnings D/E10. This payout ratio has been decreasing steadily over the decades.

Think through future dividend cuts carefully. Something similar to the S&P500 with non payers removed should behave as has the S&P500. Portfolios weighted to companies with high dividend payout ratios could face cuts as high as 15% or 20%. This corresponds to the S&P500 in the late 1940s. Payout ratios were high and dividend cuts were deep.

Have fun.

John Walter Russell
August 12, 2008