Are Dividend Stocks too good to be true?
I’m a fierce defender of dividend growth investing. For the record, my portfolio is 100% invested in dividend paying stocks. Still, I think it’s time to wonder if a dividend bubble is about to bust…
Dividend Growers to the top
The popularity of dividend stocks has grown significantly over the past decade and there are several reasons for it. One of them is a magic word among investors; performance. Since the 2008 meltdown, dividend growers have been outperforming the overall stock market. For example, you can see how the Dividend Aristocrats, companies with over 25 consecutive years of dividend increase, have done:
When you try to explain this phenomenon, there is a quite obvious reason standing. Companies that have been able to grow their dividend payments each year for at least 25 years obviously have a strong business model. Those are the kind of businesses generating excess of cash flow. During more difficult period, they are also the kind of companies that will have more chances of surviving.
But there is an additional reason why dividend payers have been so popular lately. This reasons is linked to income seeking investors…
There is no interest anymore
Yeah…. Wherever you look on the South or North side of the border, you will notice an obvious trend: interest rate has gone down and are staying low. I have another secret for you; this will not change in the next 10 years!
The FED is chickening out two times out of three when it’s time to increase their rates and the Bank of Canada has dropped their rate once more due to the oil bust of 2014. Therefore, if you are retired or simply seeking for income, you can’t really go into bonds or CD’s anymore. You need to take additional risk and invest your money in dividend stocks.
Valuation at its peak
Both performances and the eternal quest for income have put the stock market in a strange position; a bull market that never ends. The trend is even more obvious on the US market, but the Canadian stocks have also done well. However, this is not completely motivated by fundamentals. The following graph shows you the average PE ratio… the market is clearly overvalued…
In comparison, the PE ratio average of dividend aristocrats now stands at 23.57 (source: Dividend Stocks Rock) while my personal portfolio average shows 25.90 (mind you, Helmerich & Payne (HP) trades at 71.98 in this calculation). Without HP, my PE average falls at 21.71.
Funny enough, I wrote in 2011 that I was using a PE ratio under 20 for all stock filters. If I do that today, my search results will be a narrower to say the least. It has become very hard to find great buying opportunities in this market and the fear of entering into a bubble grows each day.
Are we getting into a Dividend Bubble and How to Avoid the worst
To the question: are we getting into a dividend bubble? I would answer by yes… and no. I think that there is a dividend bubble right now but only for a specific group of stocks; those which are paying over 5% yield. The problem which this kind of company is that their weaknesses are completely covered by the bull market. They all do well and they find even more investors to push their stocks higher during such period. When things go sour, those companies will hit rock bottom.
However, the rest of the solid dividend paying stocks are, at worst, subject to a correction as the rest of the market. But that doesn’t matter. If you select the right dividend paying stock, you will be paid while your portfolio go down. Sooner or later, Mr. Market will bounce back again and you will see your portfolio going back. But your dividend payment will not suffer. Therefore, if you want to avoid the worst and not fall into company that are being too generous, here’s a quick fix that will help you.
- Step #1: Determine a strong investing strategy (you can read my set of dividend growth metrics as a starting point)
- Step #2: Ignore high dividend yield, but don’t forget about smaller yielding stocks (you can read my case study part 1 and part 2)
- Step #3: Use a strong valuation model (you can read mine here)
- Step #4: During a market correction, just get yourself a Netflix membership, a big bag of chips, a bottle of wine and watch something like Billions ?