Retirement investors: Dividend or valued stocks?

Your Investments: If you are a retirement investor, the last thing you want is to be buying high.

By AARON KATSMAN
traders watching stocks (photo credit: Rafael Marchante/Reuters)
traders watching stocks
(photo credit: Rafael Marchante/Reuters)
With interest rates near zero, investors have been desperately seeking yield. As a result, one of the hottest trades for investors over the last three to four years has been buying large companies that pay high dividends.
Investors have turned to “blue-chip” companies, like Johnson and Johnson or AT&T, that they know and that pay dividends significantly higher than they can get on a bond or bank deposit.
It’s gotten to the point that high-paying dividend stocks have turned into an alternative to bonds.
Look out. Time and again people forget that even though a stock pays a 4 percent to 6% dividend doesn’t mean it can’t lose 40%-50% of its principal value. We have seen it happen time after time. And for a retiree that can be devastating.
The media is full of headlines like “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.
Cause
Why have we seen such a run-up in dividend stocks? Because investors were scared out of their minds after the financial crisis and decided the safest thing to invest in was to buy quality names that they recognized. After all, the global economy maybe in ruins, but people are still going to wake up and brush their teeth every morning.
According to Joseph Paul, chief investment officer of US Value Equities at Alliance Bernstein: “It’s understandable why investors became so risk averse after global markets collapsed five years ago. But we think it went too far. The crisis prompted a seismic shift in how investors think about returns, as people lost faith in the ability to profit from the capital appreciation of stocks. As a result, flows to fixed-income funds dwarfed flows to both US and non-US equity funds from 2008 to 2012, as investors preferred assets perceived as safer. Passive equities have become increasingly popular, while investors have shunned active strategies. And investors flocked to equity strategies focused on stocks with higher dividend yields while abandoning large-cap value equities, which are considered among the riskier types of stock investments.”
Data
This continued shift into “safe” dividend stocks comes with a bit of irony. As these stocks continue to rise in value, they are getting more and more expensive, thus bringing into question their relative “safety.”
Paul continues: “Even investors shifting toward passive equities have unwittingly exposed themselves to the same risks. For example, by late 2012, 42% of the S&P 500 Index’s total market capitalization was invested in high-dividend-yield stocks, near the top of its historical range since 1970. Meanwhile, only a quarter of the market was invested in stocks with low price to book (P/B) values, toward the bottom of its historical range.”
While funds continue to flow into high-dividend payers, data indicates that these stocks could potentially 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.”
If we see some economic improvement, don’t be surprised if institutional investors 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.Show me the money
Zlotnikov adds: “Deep-value stocks have outperformed the market significantly over time, with large bursts in out performance following prior periods when poor performance drove down their market weight. In the 12 months after earlier low points in their index weight, low-price-to-book stocks have outperformed the market handsomely: by 3.8 percentage points in the 12 months after August 1978, by 12.7 points after October 1990, by 7.5 points after December 2000, and by 10.3 points after November 2008. And indeed, the gap in market weights between low-price-to-book and high-dividend yield stocks wasn’t as wide at those points as it is today.”
If you are a retirement investor, the last thing you want is to be buying high. Remember the old investing axiom: Buy low and sell high.
Contact your financial advisor to see if you may be overexposed to dividend stocks and if a transition to value makes sense.
aaron@lighthousecapital.co.il Aaron Katsman is a licensed financial adviser in Israel and the United States who helps people with US investment accounts.