Chasing Dividends Is a Risky Investment Strategy
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Investors disappointed with tepid bond yields have been hunting for income in the stock market - boosting to near record highs the outperformance of dependable dividend paying companies and going beyond those usual suspects to corners of the market not typically known for their payouts.
In doing so, investors may be taking on added risk, analysts are warning. That is because some companies may be paying out more than they afford, or because the shares are getting overly expensive.
"A yield grab is under way that we think will likely persist," said Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America-Merrill Lynch Global Research in New York, in a July note to clients.
"Stocks with the highest dividend yields could continue to attract a disproportionate amount of assets," she said, recommending that investors focus on high-yielding companies in sectors such as telecommunications and technology that could comfortably cover their dividends and weren't overpriced.
With roughly 60% of the S&P now paying out more in dividends than 10-year Treasuries yield, it is not hard to find high-yielding stocks. But that is mainly a reflection of unusually low bond yields and not of bargain priced stocks, with the forward price-to-earnings ratio of the S&P 500 a somewhat pricey 17.2.
The S&P dividend aristocrat index, made up of S&P 500 companies that have raised their dividends every year for the last 25 consecutive years, has been outperforming the S&P 500 handily as investors buy up component company shares. At 0.45, the ratio of the aristocrats index to the S&P is well above its average of 0.4 and just a hair below its all time high of 0.46, touched earlier this month.
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But investors have also been eagerly buying up just about any stock outstripping the 1.54% yield of the benchmark 10-year Treasury.
BlackRock data for June showed high dividend funds had the highest inflows of any equity category of exchange traded products, with flows of $3.8 billion the best month on record. Almost 300 stocks in the S&P 500 are yielding more than 10-year Treasuries; that is the most in five years and second-most in the past 30 years, according to Bank of America Merrill Lynch.
While names in the energy, healthcare and telecom sectors are known for their dividend payouts, non-traditional names like retailers Staples and Kohl's have seen their dividend yields climb to, or near, record highs. Roughly one of every five companies in the benchmark S&P index is paying out over 3 percent now.
Analysts warn investors should be picky with regard to high-dividend payers, as some may be borrowing cash to pay for them instead of basing the payout on earnings.
An interest rate hike from the U.S. Federal Reserve - not widely expected until December - could signal the beginning of the end of the dividend run on Wall Street. A Fed rate hike would increase Treasury yields, diminishing the comparable attractiveness of stocks.
"As you see the prospect of a rate hike come into play, then these stocks don't necessarily decline but they stop going up and they sort of level off and go sideways," said Randy Frederick, managing director of trading and derivatives for Charles Schwab in Austin.