Dow Yield Versus Treasury Yield

There has been quite a bit of chatter recently about the widening spread between the yield on 10-Year Treasuries and the dividend yield for stocks.  Currently, the 10-Year Treasury Note is yielding 3.84% versus the Dow's dividend yield of roughly 2.6%.  One of the arguments for stocks at the bottom of the bear earlier this year was that they were yielding more than Treasuries.  As shown below, that hadn't happened in nearly 50 years.  The consensus for 2010 is that stocks will rise (dividend yields lower) while the 10-Year yield will rise as well.  This would make the spread tick lower into the "red zone" in the chart below.  You be the judge on whether this will be a negative for stocks or not.

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Comments

[Less Antman]

Since 1980, companies have increasingly been using buybacks rather than ordinary dividends, so that cash distributions far exceed the reported dividend rate. This has been discussed in many places (such as Dimson et al Triumph of the Optimists). Any honest comparison must include such distributions: current stocks aren't nearly as poorly yielding relative to Treasuries as this chart implies.

[bostonkain]

Less Antman - If a company buys back some of its shares, wouldn't its dividend yield go up since there would fewer outstanding shares over which the dividend is distributed? If this is correct, then a "distribution" through a buyback would be included in the reported dividend yield and this would be a fair comparison. I might be missing something here but thought I would throw my comment out.

[Less Antman]

You're right: a buyback increases the dividend rate on the remaining shares, but not nearly to the same extent as a traditional dividend. For example:

A company has 100 shares outstanding trading at $100 per share, for a total capitalization of $10,000. They have $400 available to distribute.

(1) If they use it to simply pay an ordinary dividend, they will give $4 to each share ($400/100 shares), for a 4% cash dividend (either $400/$10,000 or $4/$100, depending on whether you want to compute the total or each share).

(2) If they first use $200 to buy back two shares ($200/$100 price per share), then the next $200 to pay a dividend to the remaining 98 shares (100 shares - 2 bought back), they will be giving $2.04 to each share ($200/98 shares), for a 2.04% dividend (either $200/$9,800 or $2.04/$100, depending on whether you want to compute the total or each share).

Needless to say, 4% isn't the same as 2.04%, so the modern method of distributing large amounts of excess cash from corporations back to individuals in the form of buybacks is resulting in a much smaller reported yield.