Why Dividend Stocks Are Cheaper Than Ever

For years, investors have had to choose between the rich payouts of bonds and the growth potential of stocks. Now, though, as stampeding savers have bid up the price of bonds to extraordinary heights, dividend stocks have taken over the role of being the best provider of income -- and they carry a growth kicker as well.

Hello, risk premium
Throughout much of the past several decades, investors have had a decision to make when considering how to allocate their money. Bonds typically provided higher yields than stocks, but with most bonds, the interest payments you receive represented the only return you could expect from your investment. Meanwhile, if you wanted to have a chance at capital appreciation, investing in stocks usually meant accepting a lower dividend yield in exchange.

Now, though, the big rally in the bond market has turned that relationship on its head. According to Bloomberg, more dividend stocks have yields that exceed the average rate on bonds than at any time in the past 15 years. Right now, 68 members of the S&P 500 have yields exceeding 3.8%, the current average yield in the credit markets.

What that means is that investors are getting an income premium for taking on the added risk of buying stocks. That may not sound unusual, but before the market meltdown in 2008, the last time that happened was the 1950s.

What's behind the move?
How did this happen? It took a convergence of several factors to bring us to this point:

  • Bond yields have dropped precipitously, especially in the past several months. The 10-year Treasury yielded nearly 4% in April but dropped briefly below 2.5% before bouncing a bit.
  • Despite improving earnings, stocks have languished in a tight trading range since the huge rally from the March 2009 lows ended.
  • All the while, many dividend stocks have continued raising their payouts consistently, contributing to higher yields.

This last point is the most important, because it has long-term implications for investors who are seeking to take advantage of current yields as a buy-and-hold investing opportunity. Of those S&P stocks yielding 3.8% or more, about a dozen have grown dividend payouts at a 10% annual clip since 2005. Here's a selection:

Company

Dividend Yield

5-Year Dividend Growth Rate

Paychex (Nasdaq: PAYX  )

4.8%

19.4%

ConocoPhillips (NYSE: COP  )

4.1%

14.5%

Hudson City Bancorp (Nasdaq: HCBK  )

5.1%

19.8%

Reynolds American (NYSE: RAI  )

6.3%

13.3%

HCP (NYSE: HCP  )

5.1%

17.2%

CenturyLink (NYSE: CTL  )

8.1%

64.7%

CenterPoint Energy (NYSE: CNP  )

5.1%

10.4%

Source: Capital IQ, a division of Standard and Poor's. Data as of Sept. 8.

Now just because these stocks have healthy dividends doesn't mean you should run out and buy them on that basis alone. It's important to look at other factors as well. But a closer look shows that each of these stocks has managed to keep revenue growing even during the troublesome economy of the past five years. Some suffered hiccups along the way, but they bounced back and provided long-term growth -- which is all a long-term investor can ask for from a stock.

What's next?
I don't think dividend yields will stay this far above bond yields very long. That may happen due to rising stock prices that will reduce dividend yields, or falling bond prices that will close the gap between yields on bonds and stocks.

Whichever way that happens, though, dividend stocks look like a much better buy than bonds right now. Even with such high levels of uncertainty about the economy, attractive yields on dividend stocks give them a margin of safety you simply don't have with bonds right now. If you still have a big portion of your money in the bond market, take a closer look at dividend stocks and see if they might give you a better way to achieve your long-term financial goals.

Stocks are great, but you need to stay away from some of them. Alex Dumortier warns that these stocks are more dangerous than you think.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Dan Caplinger can't resist a bargain. He doesn't directly own the stocks mentioned in this article, although the dividend mutual funds he owns may own them. Paychex is a Motley Fool Inside Value choice and a Motley Fool Income Investor recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy gives you great value.


Read/Post Comments (5) | Recommend This Article (37)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 09, 2010, at 3:54 PM, SurferBill1 wrote:

    Dear Foolish Editors,

    Having hit 60 last December and then rolling over a sizable 401K plan into one of my IRAs, I thought it was time to begin dedicating a larger portion of my portfolio to dividend-paying stocks. I owned Questar (STR) for years, (recently having been reorganized into two separate operating entities), and its growth plus reinvestment of dividends has performed as a cash cow for diversifying chunks of profits into other areas. A few months ago I researched high-yield options and determined that the long-term chart and consistant dividend growth of CTL would be a prudent place for a portion of my newly available cash. Since buying this stock two months ago, The Fools have run articles that are on opposite ends of the spectrum regarding the value of investing in this company. Certainly a sure-fire way of saying "we told you so" a year from now regardless of how CTL performs. Serving up differing opinions is healthy, but I find the Fool's lack of commitment one way or the other provides more confusion than clarity.

    The integration of Quest should prove to be a boost, so I'm staying with this one until the charts or numbers say otherwise. Comments anyone?

    Foolishly yours,

    SurferBill

  • Report this Comment On September 09, 2010, at 4:08 PM, EnigmaDude wrote:

    Bill - now that you are 60, do you still surf? :)

    I am not all that familiar with CTL, but it sounds like you have a great approach to investing that has been working well for you. My gut feel is that CTL will be a good long-term investment even if the Qwest merger causes a short-term drop in performance. But I believe that they will continue to pay a decent dividend and will most likely continue to grow.

  • Report this Comment On September 09, 2010, at 6:11 PM, goalie37 wrote:

    I agree that the disparity between dividend yields and bond yields will be temporary. But what a great time to take advantage of Mr. Market's mistake!

  • Report this Comment On September 09, 2010, at 6:47 PM, errolkey wrote:

    Dividend Aristocrats are companies in the S&P 500 that have increased dividend payouts to shareholders every year for the last 25 years:

    http://www.dividend.co.nr

  • Report this Comment On September 10, 2010, at 11:28 AM, Howard1ii wrote:

    When you are calculating, the 5 year dividend growth rate, is this based on the dividend actually being increased (which might help when it comes to fighting inflation's impact) or is the growth simply due to the fact that these stock's prices are in the toilet? If so, the dividend growth rate is a pretty worthless statistic.

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