Tuesday, March 6, 2012

Dividend Stock Bubble: Is It Even Possible?

For the last 12-18 months Dividend Stocks have been on an upward spiral. Their ascent was propelled by low interest rates and the mass-media, infamous for stalking the next great fad. Following the well-worn script, the media cheerleaders are slowly swapping their pom-poms for darts as they assume their next roles as naysayers.

Recently, the news has devolved from 'everyone should own dividend stocks' to 'watch out, dividend stocks are in a bubble.' For the astute investor, one must first ponder the question: 'is it even possible for a dividend stock bubble to exist?' Let's explore this question...

Where's The Paradigm Shift?

Think back to the Tech. Bubble and the rhetoric being spewed before it busted. You heard things like 'it's the new-normal' and there has been a 'paradigm shift' when experts tried to explain why ultra-high double-digit P/Es shouldn't alarm investors.

Where are the media experts saying high double digit P/Es on the leading dividend stocks are the 'new normal?' Oh, I guess the P/Es haven't quite reached ultra-high double digits.

Yield: The Ultimate Governor

Why do people buy dividend stocks (Hint: They are not looking for unbridled growth)? Of coarse, investors  in dividend stocks are looking for income.

Q: What happens when the price of dividend stocks skyrockets?
A: Yield (and income) plummets for new investments.

When a dividend stock's price disproportionately increases and its yield declines, new investors will shy away and current investors will consider selling. This self-correcting mechanism will keep dividend stocks out of bubble-land.

Attractively Valued Dividend Stocks:

Below are several big-name dividend growth stocks that are trading below their calculated fair values:

McDonald's Corporation (MCD) is the largest fast-food restaurant company in the world, with about 33,144 restaurants in 119 countries.
Yield: 2.8% | Discount: 1.9%

Colgate-Palmolive Company (CL) is a major consumer products company that markets oral, personal and household care and pet nutrition products in more than 200 countries and territories.
Yield: 2.5% | Discount: 2.0%

Hormel Foods Corp. (HRL) is a leading processor of branded, convenience meat products (primarily pork) for the consumer market.
Yield: 2.1% | Discount: 5.2%

Microsoft (MSFT), the world's largest software company, develops PC software, including the Windows operating system and the Office application suite
Yield: 2.5% | Discount: 13.4%

Wal-Mart Stores, Inc. (WMT) is the largest retailer in North America,Wal-Mart operates a chain of discount department stores, wholesale clubs, and combination discount stores and supermarkets.
Yield: 2.7% | Discount: 19.1%

Walgreen Co. (WAG) is the largest U.S. retail drug chain in terms of revenues, this company operates more than 8,000 drug stores throughout the U.S. and Puerto Rico.
Yield: 2.8% | Discount: 38.7%

Finally, if there was a dividend stock bubble and it popped would that be a bad thing? For the dividend stocks you held when the bubble popped, the income must have been at a sufficient level, otherwise you would have sold them and purchased another stock. If you liked the stock at $x, you should really like it at $x-$y. Buy quality, and don't be afraid to hold it.

Full Disclosure: Long MCD, CL, MSFT, WMT. See a list of all my dividend growth holdings here.

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- 5 Dividend Stocks With Yields In The Sweet Spot
- How To Manage Your Dividend Portfolio In A Downturn
(Photo Credit)
Tags: [MCD] [CL] [HRL] [MSFT] [WMT] [WAG]


  1. The whole analysis overlooks an evaluation of what is considered an acceptable dividend yield for a stock to be considered a "dividend stock". That number has declined, following the decline in bond yields. If there is considered to be a bubble in the US Treasury market, then the same factors have created the bubble in the "dividend stock" evaluations. Yes, current yield spreads are positive for the dividend stocks. That does not necessarily lead to a conclusion that NOW is a good time to buy them or to buy bonds. Some times require patience and simply waiting for markets to correct.

  2. Hi DGS,
    It is somewhat unclear why 6 stocks aboce are called attractive. I've followed the link for "calculated fair values" to find a 5-option way of mixing Mid-2 Price and NPV MMA Price, each of which are separately explained and later referred to D4L-PreScreen. The spreadsheet is an interesting tool, but it may contain an error the stock balance calculation in line 19 (raising percentage to the power of X is not appropriate; adding +1to the percentage would correct it. Otherwise the 0.0125^X will be dilutive, not accretive as intended).

    What I meant to ask is for an actual calculation of fair value of the above stocks. Could you please also comment on why a 1.9% discount to calculated value of MCD makes it an undervalued stock? In my view MCD is rather overpriced and another opinion would be quite interesting to hear.


  3. Paul: When you get to the link on calculated fair values see also the links on Mid-2 Price and the NPV MMA Price. That provides all the info on how I calculate fair value.

    Line 19 is correct in D4L-PreScreem.xls. It is directly calculating the compounding effect of the growing dividend yield. Consider the following:

    1000*1.024*1.024*1.024*1.024 = 1099.51
    1000*10.24^4 = 1099.51

    My actual model of the calculation of the fair value is proprietary. As for MCD, trading at a 1.9% discount, the words I used to describe the list of stocks are "trading below their calculated fair values," which each are. MCD is trading at a discount if all the inputs to my fair value calculations are correct. To quote from my disclaimer on my stock analyses:

    "The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion..."

    Best Wishes,

  4. Hi D4L,

    The formula is correct. It looked odd, but the results are accurate, hence my apologies for implying that you had an error.

    My hope was to see your actual calculation for MCD, but fair enough - proprietary model is for your to keep or share as you deem appropriate.


  5. "Bubble" is the investment world's version of the "gate" in political scandals (watergate, iran/contragate, etc.) We can use the term bubble as a catchphrase, so to speak, but that's about it.

    Dividend stocks might or might not be in a bubble. The logic used above is difficult to refute, except to observe, when did the stock market ever operate on logic?

    Is the broader market in a 'bubble'? "Last week, the estimated return/risk profile of the S&P 500 fell to the worst 2.5% of all observations in history on our measures," -- mutual fund manager John Hussman, 3/5/12

    Current S&P 500 dividend yield is 2%. Median yield is almost 4.3% and mean yield is just above 4.3%.

    Dividend yields in the range of 2.5 to 3.5% are above the current S&P yield, but well below historical average yields. Dividend-yield stocks in many cases are a significant component of the S&P 500 index and hence a significant part of all the money that in some manner tracks the S&P 500 index. Will these somewhat higher-yielding dividend stocks decline when the S&P 500 bubble busts? It is inevitable. Will they perhaps decline less than the 'average' stock? Quite possibly.

    1. If you can be (and remain) happy when your stocks go down a 'mere' 40% when the overall market is down 50%, then dividend stocks might be a place for you.

    2. If you have a truly long investment time frame, then maybe dividend stocks at current prices are a place for you. An investor, say, age mid-40s likely is better off in this regard than say, an investor late-60s. But that mid-40s investor better have patience in large amounts. A fair number of investors do not have that level of patience.

    If you are uncertain about any of this, now is not the time to test the waters.


    Long: dividend stocks but pretty dang cautious these days.