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 |
4.8% |
19.4% |
|
ConocoPhillips |
4.1% |
14.5% |
|
Hudson City Bancorp |
5.1% |
19.8% |
|
Reynolds American |
6.3% |
13.3% |
|
HCP |
5.1% |
17.2% |
|
CenturyLink |
8.1% |
64.7% |
|
CenterPoint Energy |
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.
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