Surge in Prices of Dividend Stocks Raises Concern They’re Overvalued

Tuesday, 30 Apr 2013 08:05 AM

By Dan Weil

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Dividend stocks are soaring, thanks to the Federal Reserve’s low interest-rate policy, and some experts wonder whether these stocks are becoming overvalued.

For example, Procter & Gamble carries a 3.1 percent dividend yield and is expected to register earnings-per-share growth of 6 percent this year. Meanwhile Google has no dividend, but is expected to produce earnings growth of 18 percent this year.

So which stock has the higher price-earnings ratio? P&G at 18. Google’s ratio is 16.6.

Editor's Note:
An $87,500 Tax Loophole Discovered by Cherry Hill Accountant

It’s all about the dividend. Many slow-growing companies with dividends are receiving more attention from investors than fast-growing companies without dividends are.

"You have these tech companies that have double-digit earnings growth, no debt, huge cash balances and they're trading at 12 times forward earnings, while you have a utility in Ohio at 16 times earnings," James Swanson, chief investment strategist at MFS Investment Management, told The Journal.

"If you don't think there's a recession coming, how far do you go with this game?"

The boost in valuations of dividend companies, sparked by yield-hungry investors, is "the biggest glaring discrepancy I see in the market," he said.

Donald Taylor, a portfolio manager at Franklin Templeton Investments, believes this price discrepancy will last for a while.

"The macro environment that has caused utilities and telecoms, as well as consumer staples, to be expensive relative to history … is not at all likely to change anytime soon," he noted.

"This is not a product of equity investors buying defensive stocks and hiding out," Chris Wallis, chief investment officer of Vaughan Nelson Investment Management, told The Journal.

"What we have is money that had typically gone to fixed income now coming into equities," he added. "They're looking for bond substitutes and it doesn't mean that the money is going to exit and go either to cyclical stocks or go to cash. I think it's going to stay where it is."

Income-seeking investors don’t have an attractive set of choices in front of them, according to Michael Aneiro of Barron’s.

“People have been arguing for months, if not the past couple of years, about whether dividend stocks are overbought, and they may well be so, especially compared with other types of stocks,” he wrote.

“But it’s equally true that bonds (just about all kinds) are overbought, and interest-rate risk for bonds is at a peak point too. So if you’re looking for income, you pretty much just have to pick your poison these days.”

Editor's Note: An $87,500 Tax Loophole Discovered by Cherry Hill Accountant

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