Fortune’s Tully: Dividend Stocks Aren’t in a Bubble

Wednesday, 31 Oct 2012 08:18 AM

By Dan Weil

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Dividend stocks have rocketed higher over the past 3 ½ years as investors scurry for yield, raising fears of a bubble.

But Shawn Tully, Fortune’s senior editor-at-large, isn’t afraid.

“So are dividend stocks still a good investment?” he asks.

Editor's Note: See the Disturbing Charts: 50% Unemployment, 90% Stock Market Crash, 100% Inflation

“The answer is a resounding yes. The challenge is shifting from the traditional, overbought categories of income stocks into more overlooked choices.”

Dividend stocks still make sense partly because earnings have crested. Stock returns generally equal earnings growth plus dividend yield, but if a company does not pay a dividend, the return is just equal to earnings growth.

Investment luminaries such as Rob Arnott of Research Affiliates and Cliff Asness of AQR Capital expect earnings growth of just 4 percent. Add the 2 percent dividend yield on the Standard & Poor’s 500 and you have 6 percent returns.

So dividends can play a major role. And if you can find dividend stocks with 3 or 4 percent yields, that will give your returns even more juice, Tully says.

You don’t necessarily need to stay away from high-dividend stocks.

"Paying dividends forces companies to choose the most profitable investments with the limited earnings they retain," Robert Shearer, manager of BlackRock's Equity Dividend fund, tells Tully.

Pat Dorsey, president of Sanibel Captiva Investment Advisers, takes issue with Tully on this point.

“I think the single biggest theme, really, is to basically not think of instant gratification,” he tells Morningstar.com. “Current yield tends to be overvalued. Future growth and income tends to be undervalued.”

Editor's Note: See the Disturbing Charts: 50% Unemployment, 90% Stock Market Crash, 100% Inflation

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