On Wall Street it appears that a good thing has to always end in a bubble as investors follow the herd.
With interest rates on government debt so low, naturally investors finally began flocking into high dividend-paying stocks in the 2nd half of 2011. It only makes sense to grab a 4% yielding large cap when the 10-year Treasury pays a sub 2% rate.
What doesn't make sense though is that investors have begun flocking to dividend-paying stocks with reckless abandon. The thought process is apparently void of any concept that capital appreciation or at least stabilization is so crucial in that 4% dividend paying off.
Bristol-Myers Squibb (BMY) is a prime example of a stock that was yielding over 5% as recently as August where the yield has dropped below 4% and investors continued piling into the stock. The company is expected to see a drop in earnings in 2012 to $2.02, placing the forward PE over 17. Yes, analysts expect earnings to drop next year. Still want to rush into that 3.9% yield?
Not only does that not sound good, but analysts expect the 5-year growth rate as well to be negative. With the dividend at $1.36, the payout ratio will jump to a very high 67% in 2012.
This scenario isn't the end of the world, but several warning signs pop up. BMY won't be able to raise the payout with negative growth yet the stock trades at a forward PE nearly 50% higher than the roughly 12 for the SP500 (SPY).
The utility sector along various communications and consumer staple names are littered with stocks still yielding more than treasuries but trading at levels where the risk of losing capital might just outweigh the benefits of dividends.
Investors might be safe in these stocks for part of 2012, but any sign of higher interest rates would cause investors to flee these stocks. The risk of losing more capital than the dividend yield is being ignored by the market.
Below is a list of large-cap stocks with healthy dividends above 3.5%, but where the valuation doesn't align with the growth rate. Most have anemic 1- and 5-year growth rates combined with forward PE and PEG ratios that would scare an investor in a normal market not starved for yield.
|5 Year |
|Consolidated ED (ED)||3.9||3.6||3.7||16.7||4.7|
|Duke Energy (DUK)||4.5||0.7||3.9||15.4||4.0|
|Enterprise Energy Products |
|H.J. Heinz (HNZ)||3.6||8.7||7.8||14.9||2.1|
|Verizon Comm (VZ)||5.0||15.9||12||15.7||1.5|
The list even includes Verizon Communications, which trades at a more reasonable PEG ratio of 1.5, but investors need to be aware that ratio is still high for a low-growth company. It also seems very optimistic that a company the size of Verizon will grow earnings 12% a year.
The remaining stocks have off-the-chart PEG ratios even for high-growth companies. Investors need to understand that how much a company returns to investors in the form of a dividend is not as important as the investors' share of future profits.
In the above cases future earnings just aren't growing and don't justify these prices.
Disclaimer: All data sourced from Yahoo! Finance. Please consult a financial advisor before making any investment decisions.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.