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Paulo Santos, Think Finance (377 clicks)
Long/short equity, arbitrage, event-driven, research analyst
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Lately, a debate has emerged on whether due to the permanently low yields the market has been experiencing since 2008, a dividend bubble has emerged. (See also I, II, III, IV, V, VI, VII.)

The arguments indicating that a bubble might exist revolve around how investors are now paying a higher valuation premium for dividend-paying stocks, and how money is leaving the market in general but flowing into dividend-paying stocks.

It's hard to say whether these arguments can win such a debate. There's research which indicates dividend-paying stocks outperform over time, and thus they probably merit some kind of premium.

However, I will not be going out on a limb here, when I say that there is, indeed, a dividend/yield bubble in the market right now. It's just not centered where the debate has been focusing. But I have evidence of this bubble. So here it goes.

The evidence

As I said, the evidence of a dividend/yield bubble is not centered on those common stocks paying their 2-4% dividends, or on the stocks that regularly increase dividends.

No, the evidence can be found in much more specific situations, namely stocks that due to their nature are depleting or liquidating assets. In spite of this nature, some of these stocks pay a high or very high current yield. In today's market, this yield is clearly attracting buyers at irrational prices, and thus we have concrete proof of a bubble. I will leave several examples below:

  • Great Northern Iron Ore Properties (GNI). GNI is a liquidating iron ore trust. Not long ago it traded over $120 even though it was clear that it would never pay out $120 before it completely shut down. Several articles on Seeking Alpha pointed this out, including one of mine, which led the stock to lose some altitude. Still, even today it trades well above what it can be expected to pay out, with its allure clearly residing in the 17.5% current yield it carries;
  • PDL BioPharma (PDLI). PDLI is basically a company that's analogous to a royalty trust with a defined maturity. This happens because PDLI drives all of its revenues from receiving royalties from patents that are soon to expire. Yet, the current yield of 8.5% as well as the seemingly outstanding fundamentals and valuation, keep on attracting new shareholders, many of which even dismiss the company's own words that it will soon liquidate, something I've warned about in an article of mine;
  • PIMCO Global Stocksplus & Income Fund (PGP). PGP is a closed-end fund that's distributing in excess of what it can hope to generate through strategies such as covered call selling. Not only that, but the fund has close equivalents that are open-end. Yet, it trades at a massive 78.8% premium to its NAV. Obviously this happens because of the 9.9% current yield, in this case resulting from monthly distributions. The yield is actually a massive 17.8% distribution on NAV and as such, unsustainable. And obviously about the same NAV performance could be acquired through its open-end cousins without any premium to NAV. I have covered this as well in one of my articles;
  • The royalty trusts. A good piece on these can be read here. As an example, BP Prudhoe Bay Royalty Trust (BPT) trades at a market value of $2.33 billion, whereas its own annual report puts the present value of the income stream that's to be expected from the trust at a mere $1.4 billion. Obviously, the current yield of 7.9% keeps on attracting investors in spite of this.

There are more examples of this yield-related irrationality permeating through the markets. Although there can be doubts on regular stocks paying 2-4% in dividend yield and trading at a somewhat elevated valuation, here no such doubts exist. There is, indeed, a dividend/yield bubble in the markets, which expresses itself in the mindless buying of these high-yielding stocks and funds.


At least on specific high yielding assets there's a clear, easy-to-see, bubble forming. The assets in this bubble tend to share two characteristics - the high yield and a propensity towards being depleting/liquidating assets.

The bubble is a function of the public's infatuation with yield and dismissal of there being no capital return at the asset's "maturity". Basically a large part of the public does not understand that an asset's effective yield can be much lower than its current yield (it can even be negative). This makes for a clear departure from fundamentals, and thus, a bubble.

Further implications

If one knows that some assets yielding 8-17% are clearly in a bubble, this can also have significant implications for other high yielding assets. What's to say that the high-yielding mREITs, such as Annaly Capital Management (NLY) and American Capital Agency Corp (AGNC) are not in a bubble of their own?

After all. these mREITs have the high yield that drove investors into irrationality in other assets, so it's quite likely that here, too, investors pushed up valuations too much - even if we can't rationally establish this, and the valuation multiples don't seem out of whack.

This is clearly food for thought.

Source: Yes, There Is A (High-Yield) Dividend Bubble