The market is doing better than you think

Last week the venerable Dow Jones Industrial Average climbed above 20,000 for the first time. The event came as a relief to newscasters who could comment on the record rather than making up a reason for why the stock market moved a little higher that day.

But it’s important to know that the nightly news usually follows the “price” version of market indexes (and averages like the Dow), which do not include dividends. That’s a shame because “total return” market indexes exist and they include reinvested dividends, which, as any long-time investor will tell you, can make a big difference.

• Do you need more stocks? »

The graph below shows both the price and total return versions of the S&P/TSX Composite. The S&P/TSX Composite tracks about 250 large Canadian stocks and has been the leading measure of the Canadian stock market for many decades. (It was formerly known as the TSE 300.)

The graph is based on monthly data from Bloomberg, which happens to start at the end of February 1987 and goes through to the end of December 2016. Over the whole period the price index (the one that does not include dividends) climbed 5.07% annually whereas the total return index (the one that includes reinvested dividends) climbed 7.79% annually.

The difference between the two is dramatic when overall rather than annualized returns are considered. The price index climbed 337% from early 1987 to the end of 2016 whereas the total return index advanced by a whopping 837%.

• Low P/E stocks unlock value »

Dividends can also make a difference over shorter periods. For instance, the price index hit a peak in the summer of 2008 before the market crashed later that year. It went on to gain 3.89% from the summer of 2008 to the end of 2016. That’s equivalent to a tiny annualized gain of 0.45%. The situation is better when dividends are added to the mix. The total return index gained 34.30% over the same period or 3.49% per year on an annualized basis. While those aren’t the best returns in the world, they are a good deal better than the near break-even results of the index without dividends.

So, when you hear about the markets on the nightly news it is important to remember that the situation is probably better than reported due to the humble dividend.

Safer Canadian Dogs

Investors following the Dogs of the Dow strategy want to buy the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), hold them for a year, and then move into the new list of top yielders.

The Dogs of the TSX works the same way but swaps the DJIA for the S&P/TSX 60, which contains 60 of the largest stocks in Canada.

My safer variant of the Dogs of the TSX tracks the 10 stocks in the index with the highest dividend yields provided they also pass a series of safety tests, such as having positive earnings. The idea is to weed out companies that might cut their dividends in the near term. Just be warned, it’s a task that’s easier said than done.

Here’s the updated Safer Dogs of the TSX, representing the top yielders as of January 31. The list is a good starting point for those who want to put some money to work this week. Just keep in mind, the idea is to hold the stocks for at least a year after purchase – barring some calamity.

Source: Bloomberg, January 31, 2017

Notes

Price: Closing price per share

P/B: Price to Book Value Ratio

P/E: Price to Earnings Ratio

Earnings Yield: Earnings divided by Price, expressed as a percentage

Dividend Yield: Expected-Annual-Dividend divided by Price, expressed as a percentage

As always, do your due diligence before buying any stock, including those featured here. Make sure its situation hasn’t changed in some important way, read the latest press releases and regulatory filings and take special care with stocks that trade infrequently. Remember, stocks can be risky. So, be careful out there. (Norm may own shares of some, or all, of the stocks mentioned here.)