Dangerous Dividends

It's been a messy year for markets, but have you seen the returns of high-dividend utility stocks?

Consolidated Edison (NYSE: ED  ) is up 25% over the last year, and by more than half over the last two years. Shares have been on such a tear lately that the stock's dividend yield has dropped to the lowest level in more than 14 years. Another utility, Southern (NYSE: SO  ) , has risen so far so fast that its dividend yield is now near the lowest on record.

Verizon (NYSE: VZ  ) shares are also up nearly a third over the last year, and have surged 80% in the last two. Cigarette giant Altria (NYSE: MO  ) is up 28% in the last year, and has been on a nearly uninterrupted 170% boom since 2009. Its sister company Philip Morris International (NYSE: PM  ) has done even better, doubling in the last two years. Its dividend yield has plunged to just 3.5% -- lower than I think anyone owning a tobacco company ever expected to see.

Frankly, it's getting dangerous.

A few months ago I used the phrase "dividend bubble" to describe the herd of investors chasing yield without much regard for value. "Blue-chip dividend stocks are not subprime bonds," I wrote. "But there's an argument to make that, just as investors ran blindly into subprime bonds five years ago in search of yield, they're running blindly, carelessly into dividend stocks today." Since then, most of these stocks have only gotten pricier.

What now?

One thing we know is that the future returns of these stocks are lower today than they were a year ago. That's just the mathematical certainty of stocks that grow faster than their earnings. But that doesn't necessarily mean shares are about to sink -- yet. Dividend stocks have likely been on a tear because interest rates on bonds and cash are pegged near zero percent, and blue chip stocks offer some of the last respectable yields in town. As long as that's the case and interest rates stay low, there's a good chance dividend stock prices as a whole will stay high.

But what happens when interest rates turn? Someday, they will. And if the current bull market in dividend stocks is being goosed by low interest rates, I don't want to be around these companies when that happens.

Now, no one knows what that will happen -- interest rates could spike tomorrow or a decade from now. People have been warning for 20 years that Japan's interest rates will rise any day now. But is the possibility of a rise in interest rates even being considered by those piling into dividend stocks? I'm not so sure, and it could be a rude awakening to those who think they're buying low-risk investments. It's an added danger that can't be ignored.

On the other hand, several commenters pointed out that, as long as you reinvest dividend payments, lower share prices are actually a boon to long-term returns. This is entirely true. But how many investors can actually hold that mentality as they see their portfolios fall? History tells us, not many. Nearly every investor claims a desire to keep a cool head and be greedy when others are fearful, but most get a reality check about how difficult that is in practice when a bear market rolls around. Have an honest conversation with yourself. Would you actually be excited to see these stocks take a big hit? Maybe you would. If not, be aware of the risk you're taking and the hype fueling these companies' returns. Always remember that there's another side of being greedy when others are fearful: being fearful when others are greedy.

I personally own all the stocks mentioned in this article, and will likely be trimming my positions once the Fool's trading policy allows me. The risk-reward trade-off just isn't that attractive anymore. For other dividend stocks our analysts still like, check out The Motley Fool's free report: "Secure Your Future With 9 Rock-Solid Dividend Stocks." It's free. Just click here.

Fool contributor Morgan Housel owns shares of Edison, Southern, Verizon, Altria, and Philip Morris International. Follow him on Twitter @TMFHousel. Motley Fool newsletter services have recommended buying shares of Southern. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (30) | Recommend This Article (127)

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 June 15, 2012, at 3:36 PM, rathbateman wrote:

    "Sell your winners & buy your losers!"

    Don't recall where I read that years ago but it's sound advice. I just sold half of my PM shares last week.

  • Report this Comment On June 15, 2012, at 4:32 PM, financeguy85 wrote:

    Morgan I agree with you on an idealogical basis. Dividend yields on many stocks are getting too low. But from a practical standpoint, the question remains: where else can you put your money? Cash earns nothing. Rising interest rates will hurt bonds as well. So all else being equal it's probably still better to own Altria at 5%, even though a couple years ago it was 7%.

  • Report this Comment On June 15, 2012, at 5:27 PM, chris293 wrote:

    who knows which way the fed., congress, or the herd will go? knowing human nature and understanding basic principles of business will help us make profitable buy and sell decisons. but the problem is it is harder than it sounds.

  • Report this Comment On June 15, 2012, at 5:33 PM, Chontichajim wrote:

    I have bailed out on a few "dividend only" stocks when they had a run like Apple and took the profit.

    There are some small banks and insurance stocks that pay good dividends and may do even better as interest rises. I would not overdo this sector, but it does provide some balance to utilities and REITs.

  • Report this Comment On June 15, 2012, at 5:48 PM, marinjames01 wrote:

    And for those of us who purchased said stocks at reasonable prices/returns, the larger risk is a company lowering their dividend.

  • Report this Comment On June 15, 2012, at 8:36 PM, steveelcpo wrote:

    I agree with financeguy. The opportunity cost of owning a good stock that has a lower dividend due to price appreciation but is still paying 3-4% is better than having that money sitting there in cash at .75%.

    The point of many of the Fool articles is to be informed, know what you are buying, and make prudent decisions given your particular situation. This article rings the alarm bell that even so-called "safe" stocks that previously were dividend leaders are now possibly overpriced; or to put it differently, present an opportunity to take your profits and reinvest elsewhere. I would say to make sure your "elsewhere" is at least as good as the ones your selling.

  • Report this Comment On June 15, 2012, at 8:59 PM, jc09058 wrote:

    I hear what you are saying but I don't really see it. The Dividend Yield might be nice to talk about but its value is still questionable in my mind.

    Anyone that is an investor has for the first goal that the company's value should increase over time. As long as that company average share price increases, a dividend investor should re-invest their dividends with a long term goal to increase their overall dividends and shares.

    The investor's second goal would be investing in a company that has a growing dividend over time. A well founded company with a good cash flow will make that happen. That increase furthers the investors goal by increasing the additional shares the they own and increases the dividends they earn.

    The third and final goal would be to monitor the company taking into account all of those factors that were originally used to make the purchase in the first price and see if they continue to be true. As long as the reasoning is still sound, taking into account any adjustments due to changes over time, you will continue to hold those shares and increase your wealth by larger jumps as time goes by. Otherwise, you sell those shares and reinvest in another company that performs to your expectations.

    My feel is that the Dividend Yield might make an OK selection criteria for average companies for finding some diamonds in the rough but it can't really tell you whether that dividend is really good or not. Plus, it is too easy for companies to manipulate the dividend yield if they choose to.

    I will take the historical prices and dividend information, 10Ks, 10Qs, and knowledge about the company. From that I will try to determine whether the company is dangerous or not and not the dividend.

  • Report this Comment On June 15, 2012, at 11:00 PM, portefeuille wrote:

    And as usual most U.S. "dividend investors" ignore the usually far "cheaper" non-U.S. companies.

    Adidas vs. Nike

    http://caps.fool.com/Ticker/ADDYY.PK.aspx

    BASF vs. Dow Chemical or DuPont

    http://caps.fool.com/Ticker/BASFY.PK.aspx

    Deutsche Bank, Credit Suisse, UBS, SAN, BNP Paribas vs. GS, MS, BAC, C, JPM, ...

    http://caps.fool.com/Ticker/DB.aspx

    http://caps.fool.com/Ticker/CS.aspx

    http://caps.fool.com/Ticker/SAN.aspx

    http://caps.fool.com/Ticker/BNPQY.PK.aspx

    Telefónica, Deutsche Telekom, Vodafone vs. T, VZ

    http://caps.fool.com/Ticker/TEF.aspx

    http://caps.fool.com/Ticker/DTEGY.PK.aspx

    http://caps.fool.com/Ticker/VOD.aspx

    ...

  • Report this Comment On June 16, 2012, at 8:29 AM, sept2749 wrote:

    I don't think the divs on these stocks are too high. The payout ratio is good, the stocks are some of the best and as for PM, well, it's like selling crack and that's why I own it. It's addictive and unfortunately it's something lots of people do. I own all those stocks you mentioned and I love 'em. Of course divs from good stocks grow and grow fast - isn't that what we want? This is not a bubble it's just time to collect some good divs.

  • Report this Comment On June 16, 2012, at 11:57 AM, portefeuille wrote:

    dividend yields and p/e of some of the stocks I mentioned above (using consensus estimates for 2013 dividends and 2013 earnings and shares prices at the close of Xetra/SIX trading).

    adidas - 2.5% - 12.9

    BASF - 4.8% - 8.6

    Deutsche Bank - 2.6% - 5.1

    Crédit Suisse - 4.2% - 5.6

    UBS - 4.4% - 7.3

    Banco Santander - 12.2% - 6.3

    BNP Paribas - 5.8% - 5

  • Report this Comment On June 16, 2012, at 12:04 PM, portefeuille wrote:

    dividend yields and p/e of some of the stocks I mentioned above (using consensus estimates for 2013 dividends and 2013 earnings and shares prices at the close of Xetra/SIX trading).

    adidas - 2.5% - 12.9

    BASF - 4.8% - 8.6

    Deutsche Bank - 2.6% - 5.1

    Crédit Suisse - 4.2% - 5.6

    UBS - 4.4% - 7.3

    BNP Paribas - 5.8% - 5

  • Report this Comment On June 16, 2012, at 2:00 PM, 1wayout wrote:

    If you bought into these companies 2 or more years ago, does it really matter what the dividend yield is today? Your yield is based on the price you paid 2 years ago.

    For example, the current yield on VZ is 4.59%. When you bought into VZ 2 years ago, you were getting around 6.28%. Today you are getting around 6.61%, based on the current $2.00 dividend and your cost basis from 2 years ago.

    Why throw that away in favor of buying a company with a lower-yield dividend at today's higher share price?

    Makes no sense to me.

  • Report this Comment On June 17, 2012, at 2:38 AM, kyleleeh wrote:

    @1wayout and sept2749

    I think the issue is not so much whether you should sell your dividend paying stocks but rather do you want to keep buying them at such high PE ratios. DEO has been my largest holding for years but when it's PE hit 20 I didn't even want to reinvest the dividend let alone keep putting new money into my position.

    Like Buffet said: "What is smart at one price is dumb at another"

  • Report this Comment On June 17, 2012, at 7:32 AM, TMFMurph wrote:

    Higher interest rates can be at least partially offset by dividend growth....and for a dividend stream builder like me, all that counts is that the rate of growth of my dividend stream outpaces inflation.

  • Report this Comment On June 17, 2012, at 3:32 PM, jgneuw wrote:

    It seems to me that the author's premise is like shooting one's milk cow to get the beef. ----- JG

  • Report this Comment On June 17, 2012, at 9:39 PM, Murville wrote:

    Does anyone have real control over the language anymore? In your article, you use the expression "these company's". "These" is the plural of "this". Therefore, "company" also must be plural. Since "company" is also modifying "returns", it must be plural possessive: "these companies' returns". But, in your defense, I'll say you're no worse than some of your commenters: "your" for "you're", for example.

  • Report this Comment On June 18, 2012, at 1:02 PM, jjr1939 wrote:

    overall we are losing our ability to communicate in writing within the guidlines of grammer, spelling & such....blame shorthand quick responces of our electronic age..it will get worse..I'm as guility as all..

  • Report this Comment On June 18, 2012, at 1:20 PM, kyleleeh wrote:

    Guidelines is the key word, because that's really all they amount to. The purpose of language is to convey information, if the person understands what you're saying then your communication was effective. I've never heard of planes colliding or patients being killed because someone used the wrong "there" in a sentence...it's really not that important unless you have OCD.

  • Report this Comment On June 22, 2012, at 11:43 AM, 88melter wrote:

    jc09835 has the right info, but in the wrong order. I am NOT primarily interested in share price appreciation. I AM interested in dividend income stability or increases. This is primary for the income investor. And, if you are not investing for income, as the Victorian Era Brits did ( one thing they actually got 100% right!) you are a gambler and a speculator, just as the Victorian Brits would label you.

    Sound balance sheets, free cash flow, etc, are all good things to track. But share prices are purely a market phenomenon, and have SO little to do with the real fundamentals of many companies that they cannot be the driving force for any sound decision making, other than to determine yields. Buy low, sell high, but hold the ones that PAY.

    As long as I am a holder, I get the income from dividends, pay my taxes like a good little Patriot, and let the rigged game called Wall St. churn itself into financial chum, which is what they are best at. Companies that pay their shareholders for their investment and their confidence are the ONLY ones worth consideration. I am slowly educating my broker to this way of thinking. He is beginning to get it.

    MBB

  • Report this Comment On June 22, 2012, at 11:58 AM, FourBees wrote:

    This article bothers me because we read TMF articles all the time describing how dividend stock outperform in the long term. I think TMF should take one side on an issue, not both sides. Taking both sides is ok if you approach the article as a discussion of the risks and benefits of dividend stocks in which both sides are well presented. As it is, this sounds like TMF is talking out of both sides of their mouth without any recognition that there is inherent conflict between articles. I know TMF experts may not agree, that is why a balanced educational article is appropriate if you want to present a view contrary to 98% of TMF articles.

  • Report this Comment On June 22, 2012, at 12:01 PM, TMFMorgan wrote:

    FourBees,

    I still firmly believe dividend stocks as a whole will outperform a broader index over the long term. This article specifically singles out a select group of high-yield stocks that currently trade at high valuations.

    -Morgan

  • Report this Comment On June 22, 2012, at 1:03 PM, TNTLV wrote:

    If you do not need the income currently consider using DRIPs and DSPPs to invest in dividend stocks and you get dollar cost averaging over time.

  • Report this Comment On June 22, 2012, at 1:09 PM, lrecap wrote:

    The Unadvertised

    Retirement Program

    DRIP

    I always had a problem with computing the "dividend" rate as a percent of the transient stock price. For, as some label them: World Dominating Dividend Growers (or WDDGS, for short) are the biggest and best companies in the

    world..., their dividends in absolute value per share remains the same for decades, or for most of these, continue to grow in absolute value. You can "trade" on market value - - - and see what you make in 30 years or you can use the DRIP approach using WDDG's and see what that provides in a few decades. Of course, the appropriate approach is to use a combination of investment methodologies. I, myself am "retired". However I continually nudge my 4 children (youngest is early 30s) to include part of their "investment" into the DRIP system with companies that will survive most eco-political environment.

    Again, dividends computed as a percent of stock price is a very short term perspective - - may be OK for "trading", but not necessarily for long term "investing" (I am getting my feet wet in trading - - but 90% of my funds are "invested" for the loonnnggg term).

    BTW, as the relative dividend grows over the years, at retirement, the dividend would be changed to be paid out as cash toward daily living expenses.

    Aspects of what I have said are of course embodied in other responses.

    My 2 cents that is growing while the dollar is being de-valuated.

  • Report this Comment On June 22, 2012, at 3:11 PM, drborst wrote:

    Morgan,

    I was feeling good about this one. I sold the three of your five stocks that I owned about a month ago (probably confirmation bias, but I'll feel good for a few minutes anyway).

    But then I read your response to FourBees, reread the article, and was disappointed. FourBees read this article as part of the MF Brand, and seems confused by differing MF opinions. I, on the other hand, read an article that I think of as "Morgan Housel branded" and have come to expect some of the better Macro outlook around, but what I got was an odd mix of Macro outlook and stock picking specifics.

    BTW, where's CaptianWidget and whereaminow?

    DRB

  • Report this Comment On June 22, 2012, at 3:49 PM, copywrites wrote:

    My take from this article is that when the price of a stock has increased to the point that it is significantly reducing the dividend % return, it is time to sell the stock because over time it will again return to its historical average % return. That can happen only two ways - the dividend is increased by the company to return it to the historical average based on the stock's current price, or, the price of the stock will drop while the dividend remains the same. So if you believe the 2nd possibility is more likely than the first, sell your stock now and take the appreciation, and repurchase it after it has dropped to the point where the dividend % is closer to its historical average.

  • Report this Comment On June 22, 2012, at 4:12 PM, Maybe38 wrote:

    As a practical matter, I suppose what you say is true, but only so if one is buying into the stocks now. Having bought into mine some time ago, my actual yield is unaffected by current prices. If, and only if the current prices show that the market overvalues my holdings, that is the time to sell.

  • Report this Comment On June 22, 2012, at 4:22 PM, gkoeninger wrote:

    Let me think a minute. US Government is trillions in debt with no end of the increasing debt in sight. Major banks bailed out and are downgraded. Inflation numbers rigged to show very low except energy and food. Vacant land or houses with taxes going up each year and little ability to roll them for a good profit. So would I rather invest in the failing economy or trust my retirement to MMM, XOM, ED, APC, etc.

  • Report this Comment On June 22, 2012, at 8:02 PM, divybuy wrote:

    You fools are too funny. At what price did you buy the companies mentioned? I purchased MO two years ago, with an 87% ROI with DRIP I am sailing. Other dividend leaders are dominant in their markets, why should I sell again? Just because the yield is going down, not in my book. The dividends increase to my original buy in, not to existing price.

  • Report this Comment On June 22, 2012, at 8:44 PM, apositt wrote:

    Is there a risk to "dividend stocks" with the approaching fiscal cliff where the dividend tax might increase? Is hedging with DVY or HDV worthwhile?

  • Report this Comment On June 22, 2012, at 9:24 PM, SearchS wrote:

    PM sadly to note: Mark this an agreement to cigs are majorly addictive, and thus will continue through most eras, to be a positive part of the portfolio at this Fool's point of view--keep the dividends rolling PM

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