# I think TSX is overvalued on yield basis



## james4beach (Nov 15, 2012)

This is just one valuation data point... I watch the yield of the TSX versus 'competing' fixed income investments and I've found this to be relatively useful, especially for spotting good buying points.

Taking the average of XIU & ZCN, after MER, currently the yield is 3.0%
I compare this to the benchmark 10-year Government of Canada bond, yields 2.55%

That gives the TSX a "spread" of around 0.5% ... in other words the stock market is compensating you an extra 0.5% versus the zero-risk option.

The reason I say the TSX is overvalued based on yield, is because the 0.5% spread is very low. Just back in May, the spread was higher at 0.8%. Last summer, June/July 2012, the spread versus the 10-year got as high as 1.6%. _That_ turned out to be a good time to buy.

Thoughts? Does anyone else look at these spreads to bonds?


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## GoldStone (Mar 6, 2011)

You should compare earnings yield rather than dividend yield. Dividends is just one of a few different ways to deploy earnings. The current earnings yield of S&P500 (for example) is very high compared to bond yields:

http://www.businessinsider.com/jp-m...3-7#jp-morgan-funds-q3-guide-to-the-markets-5

TSX is cheap relative to its own history, based on several valuation measures. P/E, P/B, P/CF, Div Yield are all below 10-year averages:

http://www.businessinsider.com/jp-m...-7#jp-morgan-funds-q3-guide-to-the-markets-52


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## andrewf (Mar 1, 2010)

james, I'm sorry, this is nonsense. Yield doesn't matter. Expected return does. A reasonable estimate of future returns (over the long term) is earnings yield plus inflation. CAPE is better. But yield alone is just wrong.


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## Echo (Apr 1, 2011)

It's just as likely that by next summer we'll look back on this summer as a good time to invest.


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## james4beach (Nov 15, 2012)

Thanks for feedback guys. I think you're right that earning yield (inverse of P/E) is the more important metric, and I'm with andrewf on the CAPE

But if looking at straight dividend yield is faulty, then what about all the people choosing dividend stocks, bank stocks, preferred shares based on dividend yield?


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## CanadianCapitalist (Mar 31, 2009)

james4beach said:


> But if looking at straight dividend yield is faulty, then what about all the people choosing dividend stocks, bank stocks, preferred shares based on dividend yield?


They shouldn't be using dividend yield as a valuation metric either


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## Cal (Jun 17, 2009)

Yeah, I am all for dividend investing. But choosing dividend stocks or preferreds based solely on yield is not a wise move.


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## andrewf (Mar 1, 2010)

james, I've been beating the drum on this topic for years. Yield doesn't matter. I say that, and it just does not compute for many posters. I can explain it every which way, and a week later they are soliciting hot dividend paying stock picks.


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## Rusty O'Toole (Feb 1, 2012)

It is a rule of thumb that gives you an idea of whether the market is overvalued, fully valued or undervalued but it is no more than that. Right now stocks are on the high side but that does not mean they can't go higher.
How did they compare in March 2009?


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## Echo (Apr 1, 2011)

From the Connolly Report - http://www.dividendgrowth.ca/dividendgrowth/

"$26.94 is average cost of a dollar's worth of dividends from Connolly Report list as of June 21 2013. The average since 2000 is $31.60; in contrast, on March 7 2009, it was $16.46."

Now that's just from his list of dividend growth stocks, not the entire TSX.


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## fatcat (Nov 11, 2009)

andrewf said:


> james, I've been beating the drum on this topic for years. Yield doesn't matter. I say that, and it just does not compute for many posters. I can explain it every which way, and a week later they are soliciting hot dividend paying stock picks.


andrew, do i have this right, you are saying yield doesn't matter in the sense that total return is the more important number ?



> It is a rule of thumb that gives you an idea of whether the market is overvalued, fully valued or undervalued but it is no more than that. Right now stocks are on the high side but that does not mean they can't go higher.
> How did they compare in March 2009?


and no metric can tell you whether a stock will be higher or lower in a month or 6-months, correct ?


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## andrewf (Mar 1, 2010)

fatcat said:


> andrew, do i have this right, you are saying yield doesn't matter in the sense that total return is the more important number ?


Yep. Yield doesn't really tell you anything.


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## doctrine (Sep 30, 2011)

Historically, isn't the yield of most stock indexes (certainly TSX and S&P 500) much lower than the yield on the 10 year bonds? Based on a more historical basis, if anything I'd say the yield advantage is bullish, not bearish. Just my opinion. You can't predict the future, but I like both the dividend yields and earnings yield available in many companies today.


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## fatcat (Nov 11, 2009)

andrewf said:


> Yep. Yield doesn't really tell you anything.


commonsense would say that this argument is correct ... my only thought is that in many areas we are seeing dominant mature companies whose growth is very slow and likely to remain so and we also see markets go sideway for periods of time, in those situations it nice to have solid dividends in hand


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## andrewf (Mar 1, 2010)

Yield is a component of total return, but to look at yield alone without looking at the other components of total return is misguided.


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## MrMatt (Dec 21, 2011)

andrewf said:


> Yep. Yield doesn't really tell you anything.


Assuming you mean dividend yield, Yield actually tells you the trailing dividend to current share price.
Nothing more, nothing less.

The problem is when people take a single datapoint or relationship and forget all the other "stuff" that gives you a complete picture.


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## warp (Sep 4, 2010)

Saying that yield doesn't matter is also just plain wrong.

Certainly if you buy a stock solely on its div yield may certainly be a mistake. For instance buying a stock just because it yields 12%. There may be reasons the stock is yielding so high...the company may have big problems, etc, and the market may be telling you a dividend decrease is coming.

However, buying an index, or specific dividend stocks when their yields are high in relation to their historical yield has proven to be a great investment strategy over the longer term. Buying solid stable dividend stocks when they are out of favour because of an earnings miss, or some short term setback, which cause their price to drop, and the yield to rise works over the long haul. If these companies also have a history of raising their dividends, you have a great chance of success.

This is basically how Tom Connolly works....though he concentates on a short list of Candian div stocks,,Fortis being his favorite.


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## warp (Sep 4, 2010)

Forgot to mention, you should read Stephen Jarislowsky's book....The Investment Zoo.

Listen to what he has to say...he is a Canadian billionaire.


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## HaroldCrump (Jun 10, 2009)

warp said:


> Saying that yield doesn't matter is also just plain wrong.
> However, buying an index, or specific dividend stocks when their yields are high in relation to their historical yield has proven to be a great investment strategy over the longer term.


^ + 1 to above post by warp.
Yield chasing is wrong, of course.
But neither can "total return" be the holy grail of investing.
Total return is a backward looking metric, just like P/E ratios and dividend yields.
There is no way to accurately predict total return for any non guaranteed investment.

Forward P/E, earnings yield etc. are based on company issued guidance, earnings estimates by analysts, etc.
Neither can those metrics accurately predict stock price crashes - either single company or broad market.


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## andrewf (Mar 1, 2010)

warp, what you're saying is that yield can sometimes be a proxy for value. But what matters in that case is value. A value stock can have a high yield or a low yield. I don't deny that value is something worth paying attention to. Dividend yield is just a mediocre way of identifying value stocks.


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## james4beach (Nov 15, 2012)

andrewf said:


> warp, what you're saying is that yield can sometimes be a proxy for value ... Dividend yield is just a mediocre way of identifying value stocks.


I think that's a good observation. So when I was looking at the TSX's dividend yield, I was (in a half assed way) getting a sense of TSX value


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## andrewf (Mar 1, 2010)

Dividend yield is particularly bad because it only measures one way of returning cash to shareholders. There are dividend stocks that are issuing new capital to pay dividends, diluting shareholders. Mebane Faber put out a great little ebook on this topic called Shareholder Yield.


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## james4beach (Nov 15, 2012)

Thanks to Bernanke, the world has gone crazy with dividends and dividend yields. Everyone is so desperate for yield that anything that pays a distribution (no matter what the origin) makes investors foam at the mouth. Mutual fund companies and ETFs are exploiting this desperation too.

On top of such a mania, unfortunately I fear that what has to happen is that many dividend paying stocks will have to fall hard.


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## Sampson (Apr 3, 2009)

james4beach said:


> I think that's a good observation. So when I was looking at the TSX's dividend yield, I was (in a half assed way) getting a sense of TSX value


Although andrewf's a smart guy, it ain't his observation.


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## andrewf (Mar 1, 2010)

I make no claim to original thought. Nor should anyone here. I have yet to see a novel non-crazy idea here that can't be attributed to someone else.


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## liquidfinance (Jan 28, 2011)

james4beach said:


> Thanks to Bernanke, the world has gone crazy with dividends and dividend yields. Everyone is so desperate for yield that anything that pays a distribution (no matter what the origin) makes investors foam at the mouth. Mutual fund companies and ETFs are exploiting this desperation too.
> 
> On top of such a mania, unfortunately I fear that what has to happen is that many dividend paying stocks will have to fall hard.




So lets take a few good dividend paying stocks from the tsx

BCE
RY
CNR
ENB
FTS


No particular reason for picking these holdings other than they have a history of paying dividends. 

So going back to pre crisis. 

What was the P/E of these stocks?
What was the payout ratio and dividend yield of these stocks at the time?

How far away are they from what was previously perceived as their normal?

So 2007 RBC Priced at $55 would be yielding 3.3% Going back to 2004 the yield was around 3.4% So with a current yield of 4.09% it wouldn't suggest the price has been bid up by people going crazy for the yield.
BCE 3.6% in 2007 5.35% currently.

These are just two I quickly looked at. But how many stocks out there are paying a substantially lower yield than they would normally be at because their prices have been bid up so much?


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## Sampson (Apr 3, 2009)

andrewf said:


> I make no claim to original thought.


I never suggested. The comment was only privy for uncollected eyes. I think the biggest benefit of this forum, and it is up to users to decipher, but there are many people with a whole tonne of knowledge here. Often it is not opinion that is passed on, but collective wisdom from real, empirical research.


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## warp (Sep 4, 2010)

[QUOTE Dividend yield is just a mediocre way of identifying value stocks.[/QUOTE]

I couldn't disagree more...looking at the current div yield of great companies, in relation to their average yield over say 5-10 years is as good a proxy for value as any other, If said company aslo has a history of raising the dividend year in and year out , at a reasonable clip, you can feel secure that you will do fine with it.

This is what Tom Connolly does, and what many value investors do. 

Once you find a candidate, loook at payout ratios, and debt levels. Having a high current ratio always helps too, as well as lowish P/E.
Buffett always said that buying a wonderfull comapny at a fair price was much better than buying a fair company at a wonderfull price.


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## andrewf (Mar 1, 2010)

In other words, you need to look at a bunch of other things instead of dividend yield, right?


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## warp (Sep 4, 2010)

andrewf said:


> In other words, you need to look at a bunch of other things instead of dividend yield, right?


Well yes, of course.
You wouldn't blindly buy a stock just because the dividend yield is high. In fact a yield that becomes too high may well be a clue to problems ahead.

Buying great solid profitable companies, with long histories of raising their dividends in 2008-2009 when their yields were anywhere from 5-12% because of the sell-off and market fears , would have produced great results........and you would have gotten those juicy yields all these years and into the future too.

Doing the same now is harder, but the premise still works.


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## andrewf (Mar 1, 2010)

In that case you're buying good companies with reasonable valuations that happen to pay a dividend.


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## doctrine (Sep 30, 2011)

^^

That sounds like a good description of what I do.


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## GoldStone (Mar 6, 2011)

^^ 

Yeah but, you have a minimum yield rule. 3% IIRC. That's quite arbitrary.


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## FrugalTrader (Oct 13, 2008)

andrewf said:


> In that case you're buying good companies with reasonable valuations that happen to pay a dividend.


Good way of describing it how dividend investors establish their watch list. For the value dividend investor, once the list is established, they purchase once the yield is higher than the historical norm.


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## andrewf (Mar 1, 2010)

Isn't it a bit arbitrary to exclude companies with low or zero payout ratios that are otherwise good companies?


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## My Own Advisor (Sep 24, 2012)

I suppose so Andrewf. Higher dividend, often low(er) capital appreciation. Modest dividend, some capital appreciation. Low yield, higher capital appreciation. It's all a trade-off is it not? 

In the end, you're looking for total returns or better still, good real returns. Dividends simply give investors a psychological advantage; they can see the money coming in vs. waiting for capital appreciation.


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## doctrine (Sep 30, 2011)

I don't find a lot of good companies that don't pay dividends, certainly not in Canada. I currently only own stock in two companies that have a yield under 3%, which is Home Capital and Finning International. But both have great valuations, which is the bottom line for me even beyond dividends. If anyone can suggest an example of a company with P/E below 10 and no dividends, I'd be happy to take a look.


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## warp (Sep 4, 2010)

Easy to find anything you want by using the US stock scereener at Finviz.com. It may be the best free stock screener around.

Want no dividends and a P/E below 10.........just screen for that.

If only we had such a great screener in Canada, for Canadian stocks!


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## avrex (Nov 14, 2010)

andrewf said:


> Dividend yield is particularly bad because it only measures one way of returning cash to shareholders. There are dividend stocks that are issuing new capital to pay dividends, diluting shareholders. Mebane Faber put out a great little ebook on this topic called Shareholder Yield.


The book Shareholder Yield: A Better Approach to Dividend Investing [by Mebane Faber] is available for *FREE* for a limited time. (Monday July 22nd)

I don't have a Kindle, but I have downloaded the book, using the above link, and am able to read it on the 'Kindle for PC' application.
Enjoy.


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## liquidfinance (Jan 28, 2011)

Thanks. I have just grabbed that from the Amazon store for my phone.


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## My Own Advisor (Sep 24, 2012)

Same, just downloaded for Kindle on PC. 

Thanks Avrex.


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## andrewf (Mar 1, 2010)

Thanks avrex. I noticed that too but forgot where I mentioned it.


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## londoncalling (Sep 17, 2011)

me too


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## cainvest (May 1, 2013)

me three ... that was a interesting read.


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## FrugalTrader (Oct 13, 2008)

Thanks Avrex, great read.


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