Dividend stocks generally do not appear to be overpriced at this time. This article explores data that supports that conclusion.
Some individual dividend stocks may have risen sufficiently in price to be considered overvalued, but overall the category still appears to be reasonably priced relative to its own recent history, and in comparison to non-dividend stocks.
In a recent article, we offered one simplistic way to begin to gauge whether an individual dividend stock is overvalued relative to itself -- to its history; as well as whether some of its non-valuation, operational dimensions are improving or deteriorating.
In this article, we examine a time series for several key valuation multiples for a large group of dividend stocks and non-dividend stocks, to see if, or to what extent, they may have become more expensive than in the recent past.
The Jackson Assignment:
In a comment to our prior article, David Jackson of Seeking Alpha, suggested appropriately that the entire dividend stock category could become overvalued. We agree that could and probably will happen, but on a broad basis, we don't think it has happened yet.
We do feel that utilities and telecomm as sectors may be pricey now, however. We'll zero in on that in a subsequent article.
For dividend investors who are picking from a universe of dividend paying stocks, they also face the risk that dividend stocks generally - ie. their "universe" - has become overvalued. To assess that, we'd need to compare valuations of a large group of dividend stocks to non-dividend stocks.
Taking David's prescription as our guide, we did just that.
As dividend income oriented investors, with yield hungry clients, we think David's question is very important and spot on.
Figure 1 provides current valuation data for dividend and non-dividend segments of the S&P 500, as well as for the S&P 500 index as a whole, and for its growth, value and Dividend Aristocrat sub-indexes.
Figures 2, 3, 4, and 5 provide valuation data for the 100 largest market-cap listed dividend paying stocks, and for the largest 100 listed non-dividend paying stocks -- whether domestic or foreign, whether in an index or not.
In a future study, we plan to analyze an even larger group of dividend and non-dividend stocks over a longer time series, and to segment the dividend stocks into those (1) that have a yield well below the market yield, (2) those that have a yield near the market yield, and (3) those that have a yield well above the market yield.
The S&P 500 Data:
Figure 1 presents two sets of data for current valuation. The blue shaded headers are dividend and non-dividend segments of the S&P 500. The gray shaded headers are for ETFs indexed to the S&P 500 or one of its segments.
To simulate something that a retail investor might actually be able to implement, we limited each segment to 50 stocks (probably the most a single investor could handle, but more than most would attempt).
The four S&P 500 individual stock segments are:
- the 50 largest stocks (by market-cap) in the S&P 500
- the 50 largest non-dividend stocks in the S&P 500
- the 50 largest dividend stocks in the S&P 500
- the 50 largest stocks in the S&P 500 Dividend Aristocrats.
The four gray shaded S&P 500 ETFs are:
The Aristocrats are those S&P 500 stocks that have paid and increased dividends every year for at least 25 years.
- The Dividend Aristocrats index (market-cap weighted) and the equal weighted 50 largest Dividend Aristocrats are each more expensive on an historical and forward looking PEG basis than dividend stocks in general.
- The 50 largest S&P 500 dividend stocks and the S&P 500 Value sub-index are less expensive than the Dividend Aristocrats, but more expensive than non-dividend stocks.
- The largest 50 S&P 500 stocks in an equal weighted portfolio are more expensive than the market-cap weighted S&P 500 index as a whole -- arising because the largest market-cap companies for the most part are slower growing than the smaller market-cap companies in the index (Apple being a notable exception).
- Except for the Dividend Aristocrats, the other categories have approximately equal forward looking PEG ratios (our view: probably indicating more of a weakness in analyst projection skills than true differences in probable futures).
PEG ratio is P/E divided by earnings per share growth rate. In this instance, the historical PEG is the twelve month trailing P/E divided by the 5 year historical earnings per share growth rate. The forward PEG is the P/E based on estimated 1-year forward earnings to the 5-year projected earnings growth rate. Also the 50 largest S&P 500 stocks are more expensive than the S&P 500 as a whole.
A PEG between 1 and 2 if considered acceptable by many investors.
The 100 Largest Dividend and non-Dividend Stocks:
Figure 2 presents valuation multiples for the 100 largest dividend stocks listed in the U.S. by market-cap, and the largest non-dividend stocks, over six-month time intervals; in each case whether domestic or foreign, and excluding ETFs.
We used the same 100 stocks selected in the most recent period in a backtest for the prior periods.
Only 95 of the 100 non-dividend stocks were available at the end of July 2010; 96 at the end of January 2011, and 97 at the end of July 2011. The missing stocks are due to IPOs and spin-offs since mid-2010. There were 99 of the 100 dividend stocks available at the end of July 2010; and 100 available thereafter. The data is based on those of the 100 stocks in each group that were available in each prior time period.
We used the month after each calendar quarter, instead of the last month of the calendar quarter to be more likely to pick up the quarterly changes in operating data that was reported for the quarter.
Figure 2: Median Values: Dividend and Non-Dividend
Figure 2 and each subsequent figure, presents several valuation multiples and growth rates for each group of stocks, then calculates the ratio of the dividend stock values to the non-dividend stock values:
- P/D is the inverse of yield (better shows the cost of dividends)
- Payout Ratio is the percent of net income paid as dividends
- Div ^ 5 Yr is the 5-year dividend growth rate
- Rev ^ 1 Yr is the 1-year revenue growth rate
- EPS ^ 1 yr is the 1-year earnings per share growth rate
- Book ^ 1 yr is the 1-year book value per share growth rate
- P/S current is the price to trailing sales (revenue)
- P/E current is the price to trailing earnings per share
- P/B current is the price to most recent book value per share
- PEG forward is the price to estimated earnings divided by the 5-year projected earnings growth rate.
We used median values in Figure 2, because of the extremes of values found in the non-dividend group that substantially distort averages. For example, one of the stocks in the non-dividend group had a P/E over 2000, and some others had P/E's in the hundreds. Medians ignore those extremes.
- the median values for dividend stocks are becoming more attractive, not less attractive (as indicated by the color shading that paints the most attractive values green and the least attractive values red)
- None of the dividend stock median values are in the "unreasonable" or expensive range.
Figure 3: Simple Average Values: Dividend and Non-Dividend
Figure 3 presents averages, which means outlier values are included. That is no big deal for the dividend stocks, but is significant for the non-dividend stocks.
- Once again, none of the dividend stock values are unreasonable or particularly expensive, and the most widely watched number (P/E) is substantially down from 12 and 18 months ago. Prices are rising, but earnings have risen to keep the P/E in an OK range.
- The forward PEG is fairly steady for dividend stocks in the broad 1.5x area -- a reasonable value.
- The forward PEG on the non-dividend stocks are not a lot different from those of the non-dividend stocks.
Figure 4: Median and Average Values: Dividend Stocks
Figures 4 and 5 present the same data found in Figures 2 and 3, but this time put the median and average data for each group side-by-side for comparison of the effect of using medians or averages. No additional key observations are made, but some readers may want to see the difference in the measurement methods.
Overall, we feel dividend stocks as a group have a way to go before they are too expensive.
Disclosure: QVM has no positions in any security named in this article as of its creation date (February 19, 2012).
Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on the QVM site available here.