Dividend safety could be myth
BOSTON — Timing matters. All too often investors succumb to the temptation to buy a stock that's been a hot performer, only to get in when it's about to go cold.
One market strategist says such a turning point is approaching fast for many dividend-paying stocks. They've been popular because dividend stocks are frequently touted as a relatively low-risk investment option.
“People who have been seeking safety will discover they really didn't get what they thought they were buying,” said Seth Masters, chief investment officer with mutual fund company and asset manager AllianceBernstein.
It's easy to understand the appeal of dividend stocks, often favored by retirees and other investors seeking to generate income from their portfolios. With inflation now at about 2.2 percent, dividends offer greater potential than many bond investments to keep pace with rising prices.
For example, 10-year Treasurys now yield about 1.6 percent. That's substantially less than the average 2.7 percent yield of dividend-paying stocks in the Standard & Poor's 500 index.
Dividend-payers typically have more cash on hand and steadier income than growth-oriented companies. So dividend stocks tend to fall less sharply when the market declines.
That safety message is getting through. Mutual funds specializing in dividend-paying stocks have attracted more than $60 billion during the last three years. That number would not normally be impressive, except that cash has flowed in as investors pulled out of nearly all other types of stock funds.
Even so, Masters said it's time to take a critical look at dividends. At a recent presentation in Boston, he told AllianceBernstein clients that buying these stocks at current prices could be much riskier than an investor might expect.
The concern is that the stocks paying the highest yields have appreciated more rapidly than most other stocks since the market hit bottom in 2009.
Masters cites data showing that these high-yielding stocks have gained so much that they have recently traded at a 50 percent premium to their historical average. That premium is calculated based on the average price-earnings ratio since 1951 for the 20 percent of stocks with the highest dividend yields. The P/E ratio, divides a company's stock price by the company's annual earnings per share. A higher ratio suggests a stock is expensive because, in a sense, it takes more years of earnings for investors to get back they paid for it. A lower ratio suggests it is cheap.
Masters believes it's only a matter of time before prices of those top dividend-payers get back in sync with the historic average. That means these stocks would eventually underperform other segments of the market.
Due the strong gains for such top dividend-payers, these stocks make up a greater share of the S&P 500 index than they did a few years ago. The highest-yielding dividend payers account for about 44 percent of the market cap of stocks in the S&P 500, up from an average 34 percent dating to 1970, Masters says.
These stocks have gotten “extremely expensive,” he said.
Dividend stocks could also become less attractive from a tax standpoint, especially for investors in the top income bracket. Dividend income has been taxed at a maximum 15 percent since 2003. That rate will expire in January unless Congress and President Obama reach a compromise first on taxes and government spending. Dividends would be taxed as ordinary income in 2013, and rates would go up depending on which income bracket a taxpayer is in. For the highest earners, the dividend rate would jump to 43.4 percent.
By expressing concern over the current prices of the market's top dividend payers, Masters is not suggesting stocks are overpriced generally. In fact, he sees strong potential, with stocks priced slightly below their historic average P/E ratio. Current risks abound, from challenges such as the so-called “fiscal cliff” to Europe's debt crisis. But Masters said companies generally have modest debt and plenty of cash.
He sees the best current opportunity in value stocks, which he defines as stocks that are priced low relative to the book value of the underlying company. That's the value of the assets on a company's balance sheet minus its liabilities.
While many value stocks pay dividends, not all do, and Masters anticipates an abundance of potential bargains in the group.
Stocks in the least expensive 20 percent of the S&P 500 based on price-to-book values are trading at a discounted level that's comparable to the bargain-bin prices when stocks hit bottom in March 2009.
“Cheap stocks are very, very cheap today, relative to any time in long-term history,” Masters said. “That makes them very compelling.”
But Masters cautions investors not to expect a big short-term gain from moving their money into value stocks.
Markets can be so unpredictable in the short term that it's hard to say when such an approach might pay off.
Show commenting policy
TribLive commenting policy
You are solely responsible for your comments and by using TribLive.com you agree to our Terms of Service.
We moderate comments. Our goal is to provide substantive commentary for a general readership. By screening submissions, we provide a space where readers can share intelligent and informed commentary that enhances the quality of our news and information.
While most comments will be posted if they are on-topic and not abusive, moderating decisions are subjective. We will make them as carefully and consistently as we can. Because of the volume of reader comments, we cannot review individual moderation decisions with readers.
We value thoughtful comments representing a range of views that make their point quickly and politely. We make an effort to protect discussions from repeated comments either by the same reader or different readers.
We follow the same standards for taste as the daily newspaper. A few things we won't tolerate: personal attacks, obscenity, vulgarity, profanity (including expletives and letters followed by dashes), commercial promotion, impersonations, incoherence, proselytizing and SHOUTING. Don't include URLs to Web sites.
We do not edit comments. They are either approved or deleted. We reserve the right to edit a comment that is quoted or excerpted in an article. In this case, we may fix spelling and punctuation.
We welcome strong opinions and criticism of our work, but we don't want comments to become bogged down with discussions of our policies and we will moderate accordingly.
We appreciate it when readers and people quoted in articles or blog posts point out errors of fact or emphasis and will investigate all assertions. But these suggestions should be sent via e-mail. To avoid distracting other readers, we won't publish comments that suggest a correction. Instead, corrections will be made in a blog post or in an article.
- Judge refuses to reduce bail for McKeesport robbery suspect
- Civic organization donates to Clairton Police Department
- Pirates’ Worley tosses 4-hit shutout vs. Giants
- West Mifflin woman held for court, accused of leaving baby unattended
- The left’s dark money manager
- Approval for Wal-Mart closer in McCandless
- Pirates expect high prices in trade market
- Steelers hoping that youth movement breathes life into team
- Killer sharks are taking over the air, and the airwaves
- Westmoreland women stole thousands to finance dog show appearances
- Freeport grad picks PSAC’s Mercyhurst