Why Dividend Investors Do Not Have To Worry About A Bubble

Includes: AMZN, BDX, BP, EMR, MO, WBA
by: Tim McAleenan Jr.

I would be a terrible growth stock investor. I was recently checking out the $215 stock price for shares of Amazon (NASDAQ:AMZN), and quickly realized that I had no idea how to determine the proper valuation for a stock like that. If Amazon fell to $121, I'd have no idea if that meant the stock had become a buy. After all, Amazon would still be trading at 100x earnings at that point. Would a 40% fall indicate cheapness if Amazon still traded at 5-6x the valuation of the overall market? And what about the people who think Amazon is currently fairly valued? The late Illinois Senator Everett Dirksen is famous for saying, "A billion here, a billion there, and pretty soon, you're talking about real money." That's kind of how I feel about the P/E ratio of a stock like Amazon. Doesn't it matter at some point? If 180x earnings isn't too pricey, what is? 300x earnings?

The good news is that it is easier to get a handle on valuation with mega-cap blue chip stocks that pay regular dividends. There's an emerging conventional wisdom out there that goes something like this, "Interest rates are at an all-time low. Investors are starved for income. Therefore, they're looking to dividend -paying blue-chip stocks. This is causing the prices to rise to the point that we might be entering a dividend bubble." This notion might have some truth to it, but I think that investors can find a lot of wisdom in Benjamin Graham's response to a young Warren Buffett's question: "What if everything gets too expensive?" Graham responded: "There's always something intelligent to do in the market."

That's why I find it helpful to keep in mind that dividend growth stocks aren't all some monolith entity that share the same pricing at all times. Altria (NYSE:MO) is trading at 21x earnings right now. Over the past 20 years, there's been plenty of opportunities to buy tobacco companies at 15x earnings or less. Now might be a time to be patient if looking to purchase Altria.

But here's the fun part of dividend investing, and even investing in general: all you have to do is find one good place to invest your money at a given time. The actual stock selections may vary from investor to investor, but I do think it's helpful to keep in mind that we live in a world where Walgreen (WAG) trades at 10x earnings, Becton Dickinson (NYSE:BDX) is trading at around 13x earnings, and it won't take much of a drop for Emerson Electric (NYSE:EMR) to fall into the 12-13x earnings range. And heck, BP is only trading at a little over 5x earnings and pays out an almost 5% dividend yield.

That's why I don't worry about the talks of some nefarious dividend bubble existing out there. Right now, the stock market for dividend stocks looks like this: some stocks are cheap, and some aren't. It seems foolish to claim that a dividend bubble exists when not all dividend stocks share the same valuation. This is why I find mega-cap investing much more palatable than investing in stocks like Amazon. If a blue chip starts trading at more than 20x earnings, we as dividend investors can start to become skeptical of making an investment. This is why dividend investors don't have to be patient and worry about the existence of some bubble out there: we only have to find one Walgreen, Becton Dickinson, or BP at a time to deploy cash as part of an ongoing dividend investing strategy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.