Stocks go up and go down, over the long term, the record shows profitable companies that continue to pay dividends go up, which means if you have a reasonable time line, you will be wealthier than when you started. Sometimes stocks go down in general, why is that? The most common reasons are growth and alternatives, if growth is going to be slower than you expect, you want to pay a lower price for the stock. If the alternative to stocks is receiving a similar or higher return with less risk for example a Treasury note rates go higher, why not move your money to the least risky investment? When you listen to the news, you will hear yields are shifting. There is never a great answer, but in his book. Dean Baker author of Plunder and Blunder – the rise of the bubble economy, Polipoint Press, Sausalito, CA, 2009 outlines How to Recognize a Stock Bubble. Historically the price-to-earnings ratio or PE Ratio of the stock market is 15 to 1, and there has been a dividend payout ratio of 50 – 60% of profits, meaning shareholders receive dividend yields of 3.3 to 4%. If you add the growth of the economy of 3 to 3.5%, this gives an expected total return of 6.3 to 7.5% return  (3.3 +3 or 4+3.5%).

When the PE Ratio goes up to 30 to 1, the dividend ratio falls to 1.6 to 2%. With the growth of the economy at 2%, this means the expect real return on stocks is 3.6 to 4%. Where is the other 3% to come from? The dividends can not be increased or the company would be reinvesting any money into itself? higher stock prices? which means a higher PE Ratio? On an individual basis there can be a reason why the stock may go higher, but more it is more likely at some point stocks in general will be considered expensive and and prices will fall as the expected return on investment is too low. People are always looking at the alternatives.

Linking to dividend paying stocks, in his book Mr. Baker says we should all be all to see when a bubble economy happens, both in the stock market and real estate market, but it is hard to do action, even if you see it. Professionals use shorts, most individuals for very good reasons do not use them. If you do not use them, stick to quality dividend producing companies, even though the price will go down in a market decline, the quality dividend producing stocks bounce back before the other companies. In the end, similar to buying something at the store, quality matters.

There is more questions than answers, till the next time – to raising questions