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AARON KATSMAN \
Switch high-dividend payers for value stocks?
Trader looks at market graph 311 (R).
(photo credit:REUTERS/Tony Gentile)
One of the hottest trades for investors over the last two years has been buying
large companies that pay high dividends. With a continued weak global economy
and near-zero interest rates, investors have turned to “blue-chip” companies
that they know and that pay dividends significantly higher than they can get on
a bond or bank deposit.They have turned high-paying dividend stocks into
bonds, and that can’t be good. People forget that even though a stock pays a 4
percent to 6% dividend, it doesn’t mean that it can’t lose 40%-50% of its
principal value. We have seen it happen time after time.The media is
full of headlines such as “5 dividend stocks for a successful retirement” or
“Retirement strategy: Buy any dips in dividend winning stocks.” It’s as if there
is no need to plan for retirement, to analyze goals or needs – just invest in
dividend stocks and you are good to go. It’s the panacea for
retirement.Just to be clear, I am not at all against dividend stocks.
It’s just that when investors start substituting stocks for bonds and deposits,
I get nervous. It seems to me that the valuation on many if these stocks is very
rich. A basic rule in investing: Nothing goes up in a straight line
forever.Am I wrong? Well Kevin Mahn, president and CIO of Hennion and
Walsh Asset Management, thinks so. In an interview with Forbes, when asked
whether he thought dividend stocks were in bubble territory, he said: “Yeah, I
think what we’re finding now is any time that we see an asset class or a sector
that’s run up in value, people tend to believe that it’s the next bubble. And I
think bubble may have been an appropriate term for the mortgages in the subprime
market. But trying to extend that analogy to gold or to dividend-paying stocks
is a stretch from my perspective.“Let’s just look at dividend-paying
stocks and how they perform going all the way back to 1972. What you can see is
that in bull markets or bear markets, dividend-paying stocks actually provide a
great deal of value in all type of market environments. Consider that close to
50% of a stock’s total return historically comes from its dividend.”I
agree that not just because something increases it becomes a bubble. But when
historic data shows that things have gotten out of proportion, it pays to pay
attention.Let’s look at the data While funds continue to flow into
high-dividend payers, data indicates that these stocks could be in for hard
times ahead. Some analysts are actually starting to sound the alarm on this
dividend trade and are encouraging investors to make a move into value
stocks.Vadim Zlotnikov, chief market strategist at Alliance Bernstein
writes: “We see significant opportunity for outsize returns in deep-value stocks
and an unusually high degree of downside risk in the high-dividend payers. You
can see the opportunity by comparing the weight of the two groups within the
S&P 500.“Outperformance by stocks paying high dividends has driven
their index weight to a record high: Almost 45% of the index’s market
capitalization is in stocks with a dividend yield 20% or more higher than the
index... At the same time, underperformance has driven down the weight of
low-price-to-book stocks. Roughly 25% of the S&P 500’s market cap lies in
stocks with a price/book ratio 20% or more below the market P/B. That’s even
less than during the tech bubble!” That sounds like a bubble to me. If we see
some economic improvement, institutional investors could bail out of dividend
stocks in favor of the historically cheap value stocks. If this happens,
do-it-yourself investors should be prepared and not be left holding the bag, as
these stocks could drop.Zlotnikov adds: “If we assume a relatively
conservative 10% future outperformance by low-price/book and 10%
underperformance by high-dividend paying stocks, index investors may be leaving
almost 200 basis points annually on the table, owing to the biased construction
of the S&P 500 today. And we estimate that a portfolio with exposures to
high-yield and deep-value stocks close to the historical average could
outperform the S&P 500 by as much as 15%.”Not bad.Contact
your financial adviser to see if you may be overexposed to dividend stocks and
if a transition to value makes firstname.lastname@example.org Aaron
Katsman is a licensed financial adviser in Israel and the United States who
helps people with US investment accounts.
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