Are Dividend Stocks Becoming Overvalued?

Includes: IBM, JNJ, KO, PEP, PG, SPY, T, VZ
by: Bennington Investment Ideas

Blue chip dividend stocks have done well over the past 5 years. However, their popularity with investors raises the specter that they might be overbought (see I, II, III, IV). In many cases, their stock prices have done a better job of rebounding to pre-crash highs than the S&P 500 (SPY). This article will take a look at a select group of dividend stocks in comparison to the broader market. The following table shows the stocks reviewed:

Select Dividend Stocks
Tickers Name Recent Closing Price TTM Dividend Yield Forward Dividend Yield
SPY S&P 500 Trust ETF 139.35 1.9% 2.0%
JNJ Johnson & Johnson 69.12 3.4% 3.6%
PEP PepsiCo Inc. 72.87 2.9% 3.0%
KO The Coca-Cola Company 80.83 2.4% 2.6%
PG Procter & Gamble Co. 65.5 3.3% 3.5%
IBM International Business Machines Corporation 198.52 1.6% 1.7%
T AT&T, Inc. 37.58 4.9% 4.8%
VZ Verizon Communications Inc. 44.46 4.5% 4.7%
Source: Yahoo!Finance, Author estimates and calculations

Except for IBM, all stocks selected have dividend yields that are higher than the broader market as measured by SPY. In some cases, their yield is as much as twice that of SPY. However, the point is not that these stocks have a high yield, but rather as high yielding stocks they have outperformed the SPY since October of 2007. Their decline into spring of 2009 was also typically much less than SPY's decline. Some readers will note that this also does mean that their performance from the trough is more typical or a little worse than that of the SPY. The following table shows these returns with and without dividends.

Historical Performance
Tickers With Dividends Without dividends
Oct 2007 to Present Feb 2009 to Present Oct 2007 to Present Feb 2009 to Present
SPY -1% 102% -10% 88%
JNJ 24% 55% 6% 38%
PEP 14% 69% -1% 51%
KO 51% 120% 31% 98%
PG 9% 52% -6% 36%
IBM 86% 129% 71% 116%
T 18% 95% -10% 58%
VZ 26% 90% -4% 56%
Source: Yahoo!Finance, Author calculations

This shows that these dividend stocks have substantially outperformed SPY during the last almost 5 years. Furthermore, in some cases they have outperformed the SPY from the trough in the spring of 2009, despite having had much smaller declines. In fact, IBM dropped just 21% from October 2007 to February 2009, while SPY declined 52%.

So does this mean that these companies are growing their earnings at a faster pace? Not necessarily. In most cases, these stocks also carry higher P/E ratios than the market as a whole. The following table shows this comparison.

PE Ratio Comparison
Tickers TTM PE Ratio Forward PE Ratio Trailing Premium Forward Premium
SPY 15.5 13.5 0% 0%
JNJ 22.0 12.7 42% -6%
PEP 19.2 16.5 24% 22%
KO 21.4 18.6 38% 38%
PG 17.9 15.7 16% 16%
IBM 14.4 11.9 -7% -12%
T 50.2 14.6 225% 8%
VZ 44.1 15.8 185% 17%
Source: Yahoo!Finance, Wall Street Journal Online

This table shows that most of these dividend stocks carry a higher valuation multiple than the market as whole. If they were growing faster or carried lower risk levels, this could be justified. Further analysis would be required to determine this relationship based on a dividend growth formula or similar perpetuity/multiple calculation.

For example, JNJ's net income dropped from $10.6 billion in 2007 to just $9.7 billion for 2011. It's trailing TTM PE in 2008 based on the 2007 would be 17.7x which is lower than the current TTM PE ratio, but substantially higher than the forward. This would suggest that JNJ is in pretty good shape - it should be noted that it trades at a discount based on Forward PE ratios to the market. Another example would be KO which has seen its net income grow from $6.0 in 2007 to $8.6 billion in 2011, which was down from $11.8 billion result in 2010. In comparison, its PE ratio was around 23-24 in early 2008 based on 2007 annual EPS of $2.59, which means the PE ratio is actually contracting. These two examples show stocks with lower valuations than in 2007, but higher than the market today. Unfortunately 2008 valuations were pretty high in general - the market (S&P 500) as a whole traded at around 21-22. This would mean JNJ had a discount of around 20% and KO had a premium of around 10%. These comparisons should give investors pause to consider their dividend stocks - are they really good value today?

Disclosure: I am long SPY.

Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.