April 22nd, 2013
Are dividend stocks expensive?
Five free tickets for Master Investor Show
Dividend pay-outs drop 25% in first quarter
With dividend paying shares hitting new highs on an almost weekly basis some pundits argue that dividend income paying companies as an asset class are getting (too?) ‘expensive’.
As so eloquently
worded by James Mackintosh, FT.com’s investor editor, investors are increasingly willing to pay a premium for stocks that pay high dividends. “So much so that they are starting to look dangerously overvalued, especially in the US.”
According to JP Morgan Asset Management, the highest-yielding stocks in the S&P 500 index now trade on an average of 16 times forward earnings - that’s higher than at any point since 1994 – while the wider US market is on about 14.
Reliable US dividend payers – the ones that pay-out growing dividends year-in, year-out – trade on even higher price/earnings ratios, according to Mackintosh. It is increasingly a similar story in the UK.
Are UK dividend payers' share prices ‘overstretched’?
According to Oliver Gregson, head of UK investment advisory at Barclays, taking into account a stagnant economy and persistently high(ish) inflation:
“the level of potential wealth destruction for high-net worth clients is much higher when considering the greater relevance placed on goods such as school fees, air travel and health insurance”
No wonder, with interest rates remaining stubbornly low, people have turned to dividend paying shares and equity income funds to generate income.
In fact, it makes perfect sense that investors have turned to solid and cash-generative shares and as a result these companies’ share prices have done well – going-up – compared to other stocks, while their dividend yields have come down. As Tom Becket, of PSigma Investment Management says:
“It is all about income which means it has been the bond-like equity shares that have driven the markets higher”
But what do you do when share prices of the ‘safer’, more bond-like stocks, rise while dividend yields are coming down?
I guess, with some people expecting a wall of money to rotate from bonds and bond funds into dividend paying shares and income funds, this could go on for a while yet.
Is there a precedent?
In the late 1960ties – early 1970ties the environment was not dissimilar to the current one with an increasing number of dividend paying shares, in particular in the USA, hitting exorbitant share prices while yielding relatively little, when investors thought they would be able to increase dividends despite sluggish growth. Clearly a bubble was in the make, and, eventually many of these shares crashed and it took many years before some of these shares recovered.
While from our perspective many high quality dividend-payers are increasingly expensive, although many have not (yet) reached their historically overvalued levels, I am not sure that is going to change much in the near future unless there is a stock market crash as some 'market cycle' specialist are predicting later this year.
If the economy weakens, profits might drop, and dividends might be cut – in particular of lower quality dividend paying companies, while high quality dividend payer’s dividends may stop growing temporarily.
If the economy strengthens, interest rates might start to rise. A stronger economy would be good for high quality dividend paying companies, in the long run, while the threat of rising interest rates would hit highly indebted, lower quality dividend paying companies.
So here is what I’d suggest
In this type of environment what you need is a plan - a plan when to buy and sell a particular dividend paying companies.
At Dividend Income Investor.com, we are great believers in ‘mean reversion’. That means what is expensive will eventually get cheap; cheap shares will eventually get expensive, and vice versa. So if you buy now when a dividend paying shares is becoming increasingly expensive, you are more than likely to have disappointing results in the long run.
The big threat here is that investors are increasingly willing to pay a premium for dividend paying shares. Of course that will change one day, when shares will crash. That is why I am currently rather cash rich in my Dividend Income Portfolio.
If you are looking for a good source of information on when a high quality dividend paying share is historically undervalued or overvalued, you should take a look at Dividend Income Investor.com
We focus on high-yielding, reliable dividend payers, and purchase them when they are historically undervalued. Once we believe their dividends have become unsustainable, or when they have become historically overvalued, we sell.
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I have five free tickets to give away. Email me Here to secure your ticket. First come first.
Dividend pay-outs drop 25 percent in first quarter
According to Capita Registrars latest Dividend Monitor dividends paid by UK companies plunged by a quarter in the first three months of 2013, mostly caused by a series of special dividends paid in in the first quarter 2012, notably from Vodafone and Cairn Energy.
Vodafone made a special payout in 2012 after it received a dividend from its US joint venture with Verizon. Cairn Energy returned cash following the sale of a stake in its Indian assets. These two cash returns totalled £4.4bn.
As well as the effect of special payouts, HSBC paid its first quarter dividend in December, rather than January reducing the first quarter total by £1.2bn. Also, several smaller companies, including Domino’s Pizza, Genus, DS Smith, Town Centre Securities and S&U Plc, delayed their dividend payouts into the second quarter of 2013, enabling wealthier investors to benefit from tax cuts that came into force on April 6th, creating a £120m hole in the first quarter.
Stripping out these ‘one-of’ factors, 105 companies raised their dividends while 22 cut them (including insurers Aviva and RSA), Capita estimate that the underlying dividend growth for the first quarter of 2013 was 6.1 percent - still lower than the 9.2p percent underlying growth seen in the first three months of 2012 - but comfortably ahead of inflation, as measured by the retail price index. Figures revealed last week showed inflation came in at 3.3 percent during March.
Capita Registrars kept its forecast for total 2013 with expected dividends payouts at £80.5bn, broadly similar to what has been paid out in 2012.
With UK companies awash with cash, in fact some say £700bn, Capita is expecting that underlining dividends will rise 8.6 percent over the course of the year, implying an increase in dividend growth through the rest of the year.
Happy days ahead for long term dividend income investors?
With the FTSE100 heading for 6500 is now the time to buy shares?
While returns on savings accounts remain low, inflation stubbornly high(ish) and with many dividend paying companies paying still decent dividends one thing all readers of Dividend Alerts should consider is:
Are dividend paying companies currently overvalued?
Buying dividend paying shares when they are priced too high will often lead to long-term disappointing returns.
Our unique share valuation service provides you with information the share prices at which many dividend paying companies are historically undervalued and overvalued. Our proprietary financial strength database provides you with information whether these companies can sustain and increase their dividend payments.
Find out whether any of the companies mentioned above are currently historically undervalued, overvalued or trading somewhere in-between.
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