There Is No Dividend Bubble

 |  Includes: SO, VZ
by: Alan Brochstein, CFA

Michael Santoli is apparently on vacation, and his pinch-hitter, Jacqueline Doherty, contributed a provocative "Streetwise" column to Barron's this week, "The Danger in Dividend Stocks" (subscription required). The tagline: "Mania for Income..." There has also been a lot of talk on Seeking Alpha about a potential "bubble" brewing. The most recent one, by Stockopedia, links to several others (see I, II, III, IV, V).

I know it's strange to see stocks going up at all, so any sort of rally must be a "bubble". While it's clear to me that the idea of using equities in place of super-rich bonds is finally taking off, I would suggest that it's rational, it's not really taking prices to unrealistic levels for the most part, and this is a trend that could last for a very long time. Some may recall when I first wrote about this subject 2 years ago - I was early.

We aren't in a bubble, and here is the proof. Using Baseline, I screened the S&P 500. At present, 246 names have dividend yields greater than the index yield of 2%. Of these, 175 are up less than 12% YTD. In other words, the generous dividend-payers, on average, are trailing the S&P 500. Check out these statistics for the group:

  • Average Yield: 3.5%
  • Average YTD Price Return: -0.3%
  • Average PE: 12.0
  • Average PE/10-year Median: 0.9

This doesn't look like a bubble at all! In fact, the Barron's article cited Southern Company (NYSE:SO) and Verizon (NYSE:VZ) as "poster children", but note that these two alleged "bubble stocks" are down 1% and up 8% YTD.

Now, to be fair, I did strip out the market-beating stocks. So, let's back up and run this same table with ALL of the stocks currently yielding more than 2%:

  • Average Yield: 3.3%
  • Average YTD Price Return: 6.4%
  • Average PE: 12.1
  • Average PE/10-year Median: 0.9

By the way, what separates the winners from the losers is not too surprising: Earnings growth. The four-quarter change for the losers is slightly negative, while the stocks up greater than 12% have an average four-quarter earnings growth of 18%.

Another way of arriving at a similar conclusion is to look at all of the dividend strategies employed by Standard & Poor's. Here are the four strategies and their YTD price returns:

  • Dividend Aristocrats: 10.35%
  • High-Yield Dividends: 5.61%
  • MLP: 0.60%
  • Preferred Stock: 10.47%

None of these is up as much as the S&P 500. By the way, I wrote about the Dividend Aristocrats and the surprisingly weaker performance of the High-Yield Dividend index in July, when I shared "High Dividends, Inferior Returns".

I have been sharing one of my strategies for several years, which I call my Conservative Growth/Balanced Model Portfolio. I last shared the entire model in early January (not the weightings, just the names). If you want to see what it looks like now (including the weightings), it's not too different, but you can sign up for a free trial. I believe that we have exited one company and added three new ones. I am having a somewhat challenging year in some of my strategies, but this one is narrowly beating the benchmark of 60% stocks (S&P 500) and 40% bonds (Barclays Aggregate).

By my calculation, the stocks in the model have an average price return to my target of 37%, and, with my weightings, almost 39% over the next year. Who knows if I am too aggressive, but the point is that none of these stocks looks like they are in a "bubble" to me.

As I look out, and keep in mind that I remain rather bullish, I see stocks rising sharply into year-end, with bonds, which may be in a bubble (for another discussion), likely to get trounced. While there will be some pressure in that case on some income-oriented equities perhaps, I would expect that most dividend-growth stocks will participate substantially in the rally. Why? Earnings (rising) and valuation (NYSE:LOW).

Calling things bubbles these days is fashionable, no doubt. In the case of dividend-paying stocks, I don't believe that there is evidence of a bubble at all. There is certainly money beginning to flow into this part of the market, with a lot of retail interest from what I gather, but the trend is early and justified in my view. While I think that investors that focus exclusively on dividend-payers are likely to miss out on some great action in other stocks, I don't think that they will get burned, even as interest rates begin to lift.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.