Dividend Bubble? Think Again!

I’m sure you have heard of the Wall Street Journal claiming that the Dividend Bubble is going to burst soon. If you haven’t, trust me, you are not missing much! The rationale behind a growing dividend bubble is that most investors are leaving the equity market for bonds while the most courageous are putting their “risk” within dividend paying stocks.

Do I have to tell you that 43% of the S&P500′s annualized return comes from Dividend stocks?

That dividend stocks provide a great buffer from capital losses with their regular dividend payouts?

That dividend stocks are paying the investor to wait and therefore, are less volatile than non-dividend paying  stocks?

Well I guess that I have told this to more than a few people, those who are suddenly turning towards dividend stocks since the 2008 market crash!

Between 2003 and 2007, the stock market was going so well that many investors preferred high growth potential stocks to steady dividend stocks. This is why companies became very aggressive in returning cash to shareholders; in order to keep their interest. It’s like seeing a guy go to the gym every day and following a strict diet to make sure that his wife will look at him after 10 years of marriage. But then, 2008 arrived and several companies had to cut back on their dividends due to the recession.

Since then, the companies on the S&P 500 have strengthened their balance sheets and they own now double the amount in liquid assets than they had back in 2005 (3 trillion vs 1,5 trillion in 2005). While companies are keeping an incredible amount of cash, they keep giving back to shareholders:

41% of the companies increased their dividend or share buybacks in 2009.

52% followed this trend in 2010.

68% did it in the “rough” market of 2011 (surprising, isn’t?).

Since the money keeps piling up in their bank account, we can expect as much or more dividend increases or share buyback programs in 2012, right? So who’s talking about a dividend bubble again?

What’s a bubble anyway?

If you seriously consider what a bubble is, you get the following definition according to Wikipedia:

“A stock market bubble is a type of economic bubble taking place in stock markets when market participants drive stock prices above their value in relation to some system of stock valuation.”

This is pretty accurate if you consider the latest housing bubble; we saw houses that were driven to prices exceeding their valuation. So… how do we value stocks again?

An easy way to do it would be to use the P/E ratio since it gives us an idea of what multiplier of the company’s earnings that we need to put on the table to buy a share. At the moment, the S&P500 is trading at about 14. Historically, this ratio should be between 15 and 16. Therefore, we are far from a stock bubble. While the S&P 500 includes a lot of dividend and non-dividend stocks, I agree with you that this is not the perfect way to assess if dividend stocks are under/over or rightly valued. However, I took a quick peek at my dividend holdings and found the following P/E ratio (I’ve taken VNP off since it’s not a dividend stock):

As you can see, I don’t have any stocks over a P/E ratio of 16 and most of them show a ratio under 13! So if we consider that profits are there, multipliers are low and liquidity is high; can you tell me where you see the dividend bubble?

But I’ll go even further in my analysis by taking stocks that have successfully increased their dividends over the past 6 years. They come from different sectors and are paying different ranges of dividend yield. However, they share 2 points in common; can you tell what they are?

#1 They are showing impressive dividend growth

#2 They are paying more in terms of dividend yield than they used to 6 years ago

Which means that either their dividend rose too fast… or the stock didn’t go up at the same pace…? So you are telling me that we have a bubble while stocks are not raising faster than dividend payout growth???

Honestly, I don’t see where the dividend bubble is, can you tell me?

So if you are like me (BULLISH!), you better check out those opportunities

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You probably know about it, I’ve done 29 stock analyses and formatted it into an eBook that you can download here.

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