The Anti-Dividend-Bubble-Thesis

by: Adam Aloisi

According to more than a fair share of market pundits, commentators, and bloggers, there are several asset bubbles floating around the market today. Dividend and dividend growth stocks, bonds, Internet stocks - it kind of reminds me of the opening to the old Lawrence Welk Show. While we can speculate all we want about the situation, the truth is that asset bubbles, depending on how you want to define them, can only be truly noted in hindsight, once values have substantially deflated.

Some of the well known asset bubbles of the not-too-distant-past include the late 90s growth and technology stock boom, the 1980s biotech sector frenzy, and the crumbling of the so-called "Nifty Fifty" during the bear market of the 1970s. In each case investors buying into these bubbles at their apex lost 50% or more of their capital if they held on. Indeed, companies like Microsoft (NASDAQ:MSFT), General Electric (NYSE:GE), and Cisco (NASDAQ:CSCO), poster children for the late 90s bubble, trade for about one-half, one-third, and one-quarter, respectively, of what they did in early 2000. Given this evidence and for purposes in this article, I will define a bubble as a 50% decrease in capital value.

~ Truth is tough. It will not break, like a bubble, at a touch; nay, you may kick it about all day, like a football, and it will be round and full at evening. ~

-- Mark Twain

Today, we already see indications of a rapid boom and bust cycle in Internet-related IPOs, similar to what was seen in the late 90s. Farmville purveyor Zynga (NASDAQ:ZNGA), Facebook (NASDAQ:FB), Groupon (NASDAQ:GRPN), et. al. are all down at least 50% from earlier-year highs. Assuming these stocks don't bounce back with a vengeance, history will certainly view this as Internet IPO bubble round two.

Meanwhile, with interest rates continuing to hover near historical lows, other objects of pundit criticism, dividend stocks and bonds, continue to hold their own. I have admittedly been critical at times of investors employing a pure dividend strategy, but frankly to call the thoughtful attention that is being paid to dividend stocks in a yield-starved market a bubble seems demonstrably fallacious.

I decided to take a small sampling of several popular dividend paying stocks from a variety of sectors with yields in excess of 3% to determine the severity of the supposed bubble from a valuation perspective. I chose Abbott Labs (NYSE:ABT), ConocoPhillips (NYSE:COP), Procter & Gamble (NYSE:PG), and Intel (NASDAQ:INTC) and utilized mean current FY earnings expectations for P/E and next FY EPS growth expectations for the last column.

Stock Current Yield Current P/E Next Yr. EPS GR
ABT 3.10% 13 6.3%
COP 4.68% 6 6.1%
PG 3.35% 17 7.7%
INTC 3.61% 10 7.4%

The current P/E for the S&P 500 is roughly 15 and the Wilshire 5000 is roughly 13. Peak P/E for Cisco back in 2000 was over 100, while GE and MSFT sported P/Es for GE and MSFT were better than 50. I think one would be hard pressed to think that any of the above stocks is in a bubble. PEG ratios range from COP's 1 to PG's 2.2. If the definition of a bubble is that the asset needs to drop in value by 50% over a span of time, here is what we'd have as a result, with the assumption that both earnings and the dividend stagnate during bubble deflation:

  • Abbott trading at 7 times earnings with a yield of 6 percent
  • Conoco at 3 times, yielding 9.4 percent
  • PG at 8 times, yielding 6 percent
  • and Intel at 5 times, yielding 7.2 percent

I decided to run another similar comparative analysis with another group of diverse, well known dividend stocks, this time with yields of less than 3 percent.

Stock Yield P/E EPS GR
Wal-Mart (NYSE:WMT) 2.20% 15 9.3%
IBM (NYSE:IBM) 1.72% 13 10.3%
Disney (NYSE:DIS) 1.21% 16 13.6%
Starbucks (NASDAQ:SBUX) 1.40% 27 20.8%

Again we find what I would consider reasonable PEG ratios between 1 and 2. Double the yields and halve the P/E ratios to visualize results in a future bubble scenario.

Macro implications

The global macroeconomic situation poses the biggest threat to future corporate dividend policy in my view. Multinational businesses that have already been pointing to slacking international product and service demand, will continue to see earnings headwinds as we struggle to rebound from our own financial crisis and Europe attempts to fight through its ongoing fiscal mess. Until we get better forward earnings visibility, stocks as a whole will likely continue to meander without clear direction, and weaker businesses with sketchy balance sheets and higher payouts may be forced to adjust dividend policy.

This certainly doesn't mean that dividends will disappear or that dividend stocks as a group are in a bubble. Far from it. It could mean, however, that robust dividend growth rate policies may shrink or be flatlined during a prolonged economic malaise. We are already starting to see signs of this from companies like P&G and Pepsi (NYSE:PEP). On the other hand we are seeing new dividend policies and robust increases from the likes of Target (NYSE:TGT), Dell (NASDAQ:DELL), and Cisco.

Bubble Debunked

Dividend stocks as a group are simply not in a bubble. Like other groups of equities, there may be pockets of mild overvaluation and excess (for more on this, see I, II, III, IV, V, VI, VII, VIII), but there is no evidence that a massive sell off is needed or forthcoming. The term seems to be impudently bandied about as a way to ridicule those focused on pure dividend equity strategies or as an uninformed rant on notable increased interest dividend stocks have received as a result of low risk-free yield.

In either case, the word bubble, to me, is being misapplied here and those using the word are being sensationalistic. Sometimes investors move capital towards or become enamored with a sector or asset class because of solid, foundational rationale and not because of some misguided fantasy. This is one of those cases.

Disclosure: I am long ABT, COP, GE, INTC, TGT. 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.

Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.

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