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Last week, the Dow Industrials reached an all-time high. At the same time, the Fed has been keeping interest rates at all-time lows. This low interest rate environment has driven many investors looking for income toward dividend stocks.

With all the money flowing into the stock market and specifically dividend stocks, there is a threat that dividend growth stocks will form a bubble. In fact, there has been talk of a dividend growth stock bubble for much of the past year by many opponents of dividend growth investing. I have always been one who has pointed out the many dividend growth stocks that are trading at fair valuations, but recently this practice has become more and more challenging.

Is There A Dividend Growth Stock Bubble?

The overall market has been climbing over the past year but there is no reason to believe that stocks are becoming overvalued to a point warranting worry. A quick look at the P/E ratios of the Dow at 16 and the S&P 500 at just above 18 shows that the stocks making up those popular indices are still trading at reasonable valuations compared to earnings. Yes they are higher when comparing to a year ago but they are not nearing the unwarranted levels seen the last time news stories were covered with all-time market high announcements.

So the overall market valuation is justified by earnings but what about the more niche group of stocks known as dividend growth stocks?

Let me start off by saying that I don't believe dividend growth stocks are in a bubble. However, many of the most popular dividend growth companies are trading at higher valuations compared to the overall market. Companies such as Emerson Electric (NYSE:EMR), Johnson & Johnson (NYSE:JNJ) and Coca-Cola Company (NYSE:KO), which all increased their dividend payments for at least 50-plus years in a row.

The below chart shows many of the most popular stocks found in dividend growth portfolios and their current P/E ratios compared to their 10-year average P/E ratios.

Company NameCurrent P/E10Yr Avg P/E
Clorox Company (NYSE:CLX)19.719.3
Colgate-Palmolive (NYSE:CL)22.320.2
Coca-Cola Company19.820.3
Emerson Electric20.317.5
Johnson & Johnson20.316.7
Kimberly-Clark Corp (NYSE:KMB)21.315.7
McDonald's Corp (NYSE:MCD)18.417.0
Procter & Gamble (NYSE:PG)19.819.1

As you can see all of these popular dividend growth stocks are trading at current valuations higher than the current P/E of the S&P 500. Also, all but Coca-Cola are trading at current P/Es above their 10-year average P/Es. So many of the most well-known dividend growth stocks are trading at fairly high current valuations but it is by no means a bubble. Yes they are trading higher than the current market average, but they are not extremely higher.

Other Dividend Growth Stocks To Consider

Not all dividend growth stocks are trading at high current valuations. In fact, quite a few are currently trading at great valuations compared to both the S&P 500 and their 10-year average P/Es.

I would suggest that dividend growth investors wanting to make stock purchases in the current market environment should consider some of these more out of favor dividend growth candidates.

Company NameCurrent P/E10Yr Avg P/E
Aflac Inc (NYSE:AFL)8.315.5
Deere & Co (NYSE:DE)11.415.8
Darden Restaurants (NYSE:DRI)13.713.8
Harris Corp (NYSE:HRS)9.115.4
Norfolk Southern (NYSE:NSC)13.914.0
Wal-Mart Stores (NYSE:WMT)14.716.5

As you can see, these companies are currently trading below the P/E value of the general market represented by the S&P 500. Also, many of these companies are trading at P/Es below their 10-year averages indicating the possibility of great investing opportunities.

It is important to remember that the P/E ratio isn't the sole indicator of a company's valuation. There are reasons these companies are less favorable and valued less compared to the companies in the first chart. For example, Aflac's valuation hasn't recovered since the recession of 2008. Investors are wary of the risk involved with Aflac's investment portfolio exposure to European debt. At the same time, there is a currency risk as the Japanese yen gets weaker compared with the U.S. dollar.

The P/E ratio gives the investor an initial idea of current valuation. It is important to do the proper research to determine why a P/E may be higher or lower compared with the general market averages.

Conclusion

There is no dividend growth stock bubble. Some of the most popular companies are currently trading toward the high end of a fair valuation. Investors would be wise to consider some of the less popular dividend growth stocks when looking for new investment opportunities in the current market conditions. The laws of mathematics tell us there will always be some stocks trading at P/Es higher than the general market average and some trading lower. It is the investor's job to seek out those companies offering the best current valuation compared to long-term profit potentials.

Source: Beware The Dividend Growth Stock Bubble