Buy Stocks Now While They’re “Cheap”? Perhaps, Says USA Today Commentator

Most future retirees see the recent plunge in share prices as a disaster. They’ve watched their nest eggs shrivel, and are bracing themselves for even worse. Some have ditched their stocks altogether and are now in ultra-safe CDs yielding a few percentage points at best.

A few brave souls, however, are wondering whether the current crisis presents an opportunity. Following the traditional contrarian mantra of “buy when everybody else is selling and sell when everybody else is buying,” they’re looking for bargains amid the wreckage of the stock market.

And they’re finding them. The fall in stock prices has also lowered P/E ratios and raised dividend yields. John Waggoner, writing in USA Today, points out that General Electric—traditionally considered a high-quality, blue-chip stock—is currently yielding about 6.5% in dividends. A case can be made, he asserts, for buying the stock, sitting back, and enjoying the fat yield until stock prices recover, regardless of how long it takes.

This approach appears sound. Stocks, especially quality ones, tend to rise over time, as do dividends. And dividends are tax-favored over other forms of income, so you’ll only have to pay a maximum of 15% income tax on the yield. Why not just buy GE, treat it like a bond that pays reliable quarterly payments, and ignore the ups and downs of the share price until there’s finally an “up” that you like?

It may work out perfectly. But then again, it may not. Two risk factors come into play when buying even the bluest of blue chips for their yield:

• Corporate earnings risk. If there’s a major recession, GE’s profits could tank. The company will be forced to cut dividends. There goes the fat yield. Moreover, such a move signals to the investment community that recovery won’t happen any time soon, so the share price will probably drop even further.
• Interest rate risk. Right now, bond yields are low, and 6.5% looks very attractive. The bank bailout and other measures being taken by the government and the Fed to stimulate the economy, however, essentially involve artificially inflating the money supply. Besides, the government is going to have to take on a lot of new debt to finance these measures. If either inflation increases, or overseas investors weary of buying up ever-greater quantities of U.S. debt, interest rates could surge. Then the “generous” yield might start to look stingy, which could further depress the price of the stock.

So what’s our recommendation? On this topic, we don’t have one. There’s no doubt that great fortunes have been made by those willing to step into markets where everyone else fears to tread. Great fortunes have been lost this way, too. If you want to reach for big rewards by taking big risks, go ahead. But don’t fool yourself into thinking that you’re betting on a sure thing. You’re not.