How Can You Tell If A Dividend Stock Is Overvalued?

by: Richard Shaw

How can you tell if a dividend stock is overvalued? We think comparing the current level of key data to the historical record for the same factors is one way to get at the question.

There are external relativities too, but when culling alternatives, seeing how a company today compares to how it looked on average in the past is useful. That invokes mean reversion, which is a powerful force.

As many commentators have noted, dividend stocks are quite popular for a variety of reasons, including interest rate suppression by the Fed and the search for portfolio income by a growing population of retirees.

That creates the risk that at some point too much money will have shifted to dividend stocks, creating a bubble of sorts that is destined to produce price declines.

The nature of dividend stocks and dividend investors will not allow dividend stocks to reach the extremes of valuation that non-dividend paying stocks can and have reached in the past.

Dividend yield alone is a sort of governor on price - too high a price and the yield becomes unappealing, preventing further price rise - too low a price and yield hunters step in, causing the price to rise. Dividends can have the attractive feature of assisting the forces of mean reversion with a very visible metric - yield.

What tools are available to know when much is too much?

David Jackson of Seeking Alpha recently posted that question in response to an article by Robert Martorana about how a recession might play out for dividend stocks.

In response to that question and the general need to know when and if the allocation to particular dividend stocks is too much, we put together a data array to illustrate one of certainly many possible approaches that may be helpful in that regard.

We chose Genuine Parts Company (NYSE:GPC) and Kimberly Clark (NYSE:KMB) as guinea pigs for the illustration due to their high level of popularity.

To identify those two companies as special examples of dividend stocks, we identified all of the holdings of seven leading dividend ETFs (SDY, DVY VYM, VIG, HDV, FVD and FDL) and then cross referenced those holdings to find the most widely held stocks. GPC and KMB came to the top of the list.

There are 517 unique companies held by the seven ETFs. Of those, one stock is held by all seven, and one is held by six. They are GPC and KMB, respectively. There are 30 stocks held by five of the seven funds, and 61 stocks held by four of the funds. Altogether 93 of the 517 stocks are held by four or more of the seven dividend ETFs. This sort of filtering is a regular part of our subscription service, "Rational Risk Equity Income Investor."

Figure 1 focuses on operational issues for GPC and KMB. Figure 2 focuses on valuation issues.

The table images present the current data for various parameters, and next to that is positioned historical data. The result is a self-referencing set of operational and valuation data points.

We then rendered a interpretation of the current versus historical data as either favorable, neutral or unfavorable. Favorable and unfavorable in this instance refers to improving or worsening conditions, but not necessarily to absolute levels of good and bad.

We did not produce an absolute judgment or a single rolled-up indicator about whether either stock is still a good dividend choice, but the data applied to a larger set of symbols could potentially be very helpful in choosing among alternatives.

Click images to enlarge.

Figure 1:

Figure 2:

Disclosure: QVM has long positions in KMB is some accounts as of the creation date of this article (February 6, 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.