---T.S., Dallas, TX
A. Investors tend to look beyond the immediate event and anticipate what it portends for the future. One theory of stock valuation, for instance, says that the value of a stock is equal to the present value of all its future dividends. As a consequence, when a dividend is cut by 25 cents it has long-term implications that are far greater than 25 cents.
It means, for one thing, that the entire stream of future dividends is likely to be smaller. The value of the stock, therefore, could drop by the total expected decline in the value of those dividends--- this can be quite a few dollars a share.
No, I do not mean to suggest that investors carefully calculate the likely loss of future dividends and price the stock down accordingly. But there does appear to be some kind of market calculus that works to price stocks down when the outlook for future earnings and dividends deteriorates, just as it works to price stocks up when the outlook for future earnings and dividends improves.
In addition, companies are very slow to cut their dividends because they know it will have a serious impact on their share price and that shareholders will be unhappy. As a consequence, many investors believe that a dividend cut indicates a company under severe stress that may be worse before it gets better.
Even today, dividends can mean a lot.
Q. I've noted your critique of bond funds non-competitiveness versus five-year Treasury notes. I have a ten-year ladder of Treasury bonds that I've assembled via Treasury direct. But the great majority of my investment portfolio (I'm retired) is tax-protected, primarily rollover IRAs with DLJDirect, Fidelity, and Vanguard. I currently have bond funds with each one. It seems like it's a huge hassle to buy individual bonds within an IRA. Do you know of a slick way to buy individual bonds within an IRA?
---R.R., Dallas, TX
A. You've basically got two choices. You can change your IRA rollover accounts to IRA brokerage accounts and buy Treasuries, at issue or in the after-market, through the brokerage account. Virtually all of the major mutual fund complexes now offer mutual fund supermarkets and low cost brokerage accounts. Alternatively, you can stay where you are and use the mutual fund supermarkets to acquire shares of the mutual funds that regularly do better than a 5 year Treasury in my monthly study.
The most recent five-year period study, from November 1995 through October 2000, has just been computed and uploaded to my website. A 5-year Treasury note again beat an index of 20 major government bond funds, providing a withdrawn income return of 5.69 percent while the index returned 4.78 percent. Vanguard GNMA fund, however, was at the top of the list with a return of 6.39 percent.
Of the 95 five year periods that I have tested, a simple 5 year Treasury has now done better than the index all but 14 times. That's 85.3 percent of the time.
A closer examination showed that 13 of the 14 times that a 5 year Treasury failed to beat the index occurred during periods of major interest rate declines. This tells me that the only way a managed bond fund can beat a 5-year Treasury is when it has the "tail wind" provided by falling interest rates.
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