Market strategist: Dividend safety could be myth

Associated Press Modified: November 21, 2012 at 5:00 pm •  Published: November 21, 2012
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BOSTON (AP) — Timing matters. All too often investors succumb to the temptation to buy a stock that's been a hot performer, only to get in when it's about to go cold.

One market strategist says such a turning point is approaching fast for many dividend-paying stocks. They've been popular because dividend stocks are frequently touted as a relatively low-risk investment option.

"People who have been seeking safety will discover they really didn't get what they thought they were buying," says Seth Masters, chief investment officer with mutual fund company and asset manager AllianceBernstein.

It's easy to understand the appeal of dividend stocks, often favored by retirees and other investors seeking to generate income from their portfolios. With inflation now at about 2.2 percent, dividends offer greater potential than many bond investments to keep pace with rising prices. For example, 10-year Treasurys now yield around 1.6 percent. That's substantially less than the average 2.7 percent yield of dividend-paying stocks in the Standard & Poor's 500 index.

Dividend-payers typically have more cash on hand and steadier income than growth-oriented companies. So dividend stocks tend to fall less sharply when the market declines.

That safety message is getting through. Mutual funds specializing in dividend-paying stocks have attracted more than $60 billion over the last three years. That number wouldn't normally be impressive, except that cash has flowed in as investors pulled out of nearly all other types of stock funds.

Even so, Masters says it's time to take a critical look at dividends. At a recent presentation in Boston, he told AllianceBernstein clients that buying these stocks at current prices could be much riskier than an investor might expect.

The concern is that the stocks paying the highest yields have appreciated more rapidly than most other stocks since the market hit bottom in 2009.

Masters cites data showing that these high-yielding stocks have gained so much that they've recently traded at a 50 percent premium to their historical average. That premium is calculated based on the average price-earnings ratio since 1951 for the 20 percent of stocks with the highest dividend yields. The P/E ratio, divides a company's stock price by the company's annual earnings per share. A higher ratio suggests a stock is expensive because, in a sense, it takes more years of earnings for investors to get back they paid for it. A lower ratio suggests it is cheap.

Masters believes it's only a matter of time before prices of those top dividend-payers get back in sync with the historic average. That means these stocks would eventually underperform other segments of the market.

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