Read of the Day: Are High Yield Stocks in Bubble Territory?
Good read here from Alliance Bernstein on high yield stocks:
“Investors have been flocking to high-dividend-paying stocks, lured by their predictable, bondlike income and downside defenses. But investors may be getting more risk than they bargained for.
The widespread pursuit of safety in high-yielding stocks has driven up their valuations and increased market concentration in these stocks. It has also caused an alarming surge in their correlation to bonds, so investors may be getting a lot less diversification than they realize.
Let’s look at valuations first. High-yield stocks are as pricey as they’ve been since the early 1950s, trading at a modest premium to the market versus a long-term average discount of 20%. We don’t view this premium as exorbitant given the current market anxieties, but it does limit upside potential and makes these stocks more vulnerable than others if sentiment turns. Most of the high-priced dividend-paying stocks are in mature, slow-growth sectors such as consumer staples, telecom and utilities, which are likely to look less appealing than more economically sensitive stocks in a sustained economic recovery.”
Read the full piece here.
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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28 Comments
It’s amazing to me that so many so-called experts don’t seem to understand one of the underlying core principles of dividend income investing: valuations don’t matter (much).
Yes, you can over pay for a dividend stock, and it’s ALWAYS better to buy low than high. But if you’re buying it for the income stream, it doesn’t matter how high the price gets after you already own it.
All that matters is that the dividend keeps being paid, and that they grow over time to keep pace with inflation, at a minimum. Increasing dividends is the main advantage such stocks have over bonds.
And the fact that they are correlated more closely with bonds doesn’t mean much either.
Yes, I get it that these things are important for investors looking to increase capital value. But that’s not the only game in town.
“it doesn’t matter how high the price gets ”
That seems like a pretty naive comment. Dividend stocks aren’t less risky than stocks that pay a dividend. They just have an embedded additional income stream that helps you reduce your cost basis over time assuming you’re reinvesting the dividends.
“stock that DON’T pay a dividend.” Sorry.
You’re missing my point. Capital appreciation is not the main goal.
So I’m probably not reinvesting the dividends. I’m spending them.
It doesn’t matter if I buy at 100 and it falls to 50, AS LONG AS the dividend payout stays consistent.
The dividend payout reduces the price by the amount of the dividend. If you’re not reinvesting the dividends you’re not actually benefiting from anything. You might as well buy growth stocks. The advantage behind dividend paying stocks is they pay you an income stream you can reinvest therefore lowering your basis over time.
“If you’re not reinvesting the dividends you’re not actually benefiting from anything.”
Thanks! That one made my day!
IMO, putting food in my tummy is a pretty good benefit.
What?!!!
You are not a MARKET TIMER?!!! Go wash your mouth!
How in the world can all those hard working and underpaid folks on Wall $treet make a living (fleece) folks like you? Un-American.
Yeah, I’m beginning to think LVG must be one of the fleecers…..
You think you’re not a sheep just because you buy and hold? You think Wall Street isn’t making money off you from that? You obviously don’t know what you’re talking about.
The only thing obvious from this discussion is that you need to improve your reading comprehension.
You ignore half of what I write, and imagine things I didn’t write.
The only reason to invest in stocks is to earn a share of future revenues. Price appreciation is a subordinate benefit.
Any other reasons for buying stocks is NOT investing. It is speculation.
This is not to say that one should only buy dividend payers, i.e.: growth companies.
Too many company managements feel their tenth best idea on using profits is better than their owners first best idea!
I think the point is that many people are buying dividend stocks after they have already gone up quite a lot: HD, VFC, DEO, to name a few, are looking pretty rich.
Well over 100 years of market history has shown that dividend payers have outperformed non-dividend payers by a large margin.
This is true NOT because of the dividend per se but rather the huge amount of discipline the continuation and growth of the dividend imposes on senior management.
The return of the Equity Risk Premium (premium of dividends over bonds) is not a fluke. It is a return to reality.
This could be a secular trend as baby boomers retire and look for dividend stocks and bonds to live off of in retirement. Heck, that’ll probably be my strategy one day. Consumer staples have been in an uptrend for a while and that could easily continue.
Exactly. I hope to be able to retire in 5-7 years.
I’ve spent 25 years in the capital appreciation game, now I’m transitioning to a dividend income stream portfolio. It’s a different mindset, and it took me a while to get my head around it.
I suspect a lot of baby boomer types are going the same route. That’s probably propping up share prices a bit, and by the same token, putting a floor under them.
Unless you think bonds are gonna crap out, which I don’t think many people here do, then high yield stocks should be OK.
WTF is a High Yield Stock anyway? I’ve heard of High Yield Bonds. Not sure High Yield Stocks is any kind of category.
@Geoff, a High Yield Stock is any stock that has a dividend yield greater than that of the S & P 500, which now yields about 2.0%. If you set your bar a bit higher, as I do, then for me a high yield stock is one that yields 2.5% or higher. Many of the consumer staples stocks, big pharma stocks, utility stocks, and many big oil stocks have yields greater than 2.5%. The beauty is that they increase their dividends over time, so eventually you may be earning 4% in relation to your original cost basis in these stocks when the increases are included.
Thanks, Larry. I understand the merits of stocks with nice dividends, but I’m still unconvinced that “High Yield Stocks” is a real term. It seems very arbitrary and subjective. High Yield Bonds, on the other hand, is an official category with a very specific definition, i.e. bonds that are rated below investment grade, i.e. below BBB.
Cullen,
I was reading this article on how QE has decreased the amount of AA and AAA collateral available for banks and claim it produces credit deflation. But the private banks have a excess reserves so loan creation need not a concern. (I don’t understand repo fully) but I’m not convinced this leads to credit contraction. Comments?
http://www.businessinsider.com/2013-us-treasury-supply-cliff-2012-10?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+clusterstock+%28ClusterStock%29&utm_content=Google+International
QE increases the amount of private AAA assets as reserves are essentially cash. It reduces the amount of outstanding low grade assets in the form of MBS primarily. QE bolsters bank balance sheets and reduces net interest margin which should make banks more likely to loosen lending standards to increase profits….
Just another distortion caused by zirp forever. We don’t know how to value anything, we’ve never been here before. If 10 yr treasuries are worth negative real return, what is anything worth? We’re guessing. As long as zirp can be unwound in an orderly manner things shouldn’t get too out of hand, we hope. Maybe the man in charge of that knows what he’s doing when the time comes and maybe not. Uncertainty. That’s what we got.
What it really means, there is no risk free return. You can pretty much hope to break even with low risk.
For what it’s worth, I noticed David Glasner wrote about bubbles today too:
http://uneasymoney.com/2012/10/22/theres-a-whole-lot-of-bubbling-going-on/
Of the Market Monetarist / neoclassical sympathizers I’m familiar with, David seems to at least inhabit the same universe as MRists. Cullen made a favorable comment about David Beckworth’s understanding of banking too… so I’ll have to check him out as well.
It has been my experience that the highest yielding stocks usually get big dividend cuts within a year or two. Not always, but often enough to make you think that the market is at least somewhat efficient.
It requires some research, you have to see where that dividend they are paying comes from. Are they selling off income producing assets, are they leveraging the company or is it from operating profits, and the like. This requires being able to read balance sheets.
It might be safer to use lower yield stock and use option strategies to enhance yield.
“Let’s look at valuations first”
If I buy high yield stocks (which I do) I try upfront to get the total picture. 1st part is the development of the dividends paid by the company, 2nd is the development of the share price. Over a period of 5…10 years. 3rd is, of course, the future expectations…
For instance, take Nestlé. If you bought 1000 shares in 2006, it cost you ~36.000€. Since then, they generated ~7500€ in dividends (another ~1700€ are projected for next April). Plus, the value of the shares today is at ~49.000€. Here you gained a lot on both dividends a valuation.
Another example, Österreichische Post. The stock price was in 2006 at ~36€. Today, it is at ~29€ (was as low as ~19€ in 2009). The accrued dividends for 1000 shares since 2006 is ~8700€ (another ~1800 are projected for next April). Here the dividends more than compensated the losses in valuation.
Not bad for boring value stocks, I think. Re-investing fo the dividends would of course have improved the picture further.
The search for yield will end up badly.
As with bonds this is an overcrowded trade. While presently still going marginally up, bonds are in a difficult technical juncture. If they begin to fall, yield stocks will accordingly suffer.
Regards,
While I do not deny the fact that there has been a lot of interest in high dividend paying stocks and they are probably expensive. I will pose you a question that I have been asking myself. You can buy Pfizer stock with a yield of 3.5% at present, no guarantees, but with potential capital appreciation. Or, you can buy a Pfizer bond maturing in 2039 (27 years from now) yielding 3.6% per year. If i distill it down to the basics, you are running a similar corporate risk in Pfizer with a 30 year bond as in a stock and not getting paid near as much for it.