Dividend stocks have been attractive to investors who can’t find much yield elsewhere amid ultra-low interest rates, helping push the Standard & Poor’s 500 stock index to record highs.
But the question becomes — are these high-demand stocks becoming overvalued?
The answer appears to be that some are, but there still remain pockets of value to be had.
“I do not believe that dividend-paying stocks on the whole are overvalued,” says Matt Schreiber, president of WBI Investments. “There are some … great undervalued opportunities relative to the market in general.”
[See: 6 Reliable Dividend Stocks Paying Out for 100 Years or More.]
Mike Binger, senior portfolio manager at Gradient Investments, says dividend stocks underperformed during 2014 and 2015 amid a slump in energy stocks, a strong dollar and worry that the Federal Reserve would raise rates more steadily than it has.
Also, at the beginning of the year, people thought the interest rate on the 10-year Treasury would rise throughout the year, he says. But the opposite has occurred as demand for bonds picked up in part on sluggish GDP in the developed world, a desire for safety because of fears surrounding Britain’s vote to leave the European Union and worries about its fallout.
Falling Treasury rates have become one of the reasons making equities particularly attractive right now, he says.
The S&P 500 isn’t overvalued, but price-earnings multiples are higher than historical averages, Binger says. Meanwhile, earnings growth in general has been sluggish year over year and, at some point, the Fed will deliver another interest rate hike, he says.
With that backdrop, Binger says he would not be surprised to see the stock market pull back 4 to 5 percent within the next couple of months.
But selling all dividend stocks would be throwing the baby out with the bathwater. After all, there are good companies out there, so a better strategy is to pare down some of that exposure with the eye to reinvesting the money when the market has its pullback, Binger says.
David Katz, chief investment officer at Matrix Asset Advisors, calls some portions of dividend trade “overcrowded.”
Utilities — which traditionally have been places investors flock for yield — in particular, have become significantly overvalued, he says. He predicts utilities will get hit hard when interest rates go up because their appeal compared with bonds will wane as bond yields rise.
[See: 7 Global Goats That Could Bring Market Mayhem.]
Investors should also be careful with consumer staples, he says. While they have good historical dividends, buyers should be picky about their price as some are selling at the high end of their price-to-earnings multiples, he adds.
But there are still significant pockets of stocks with good and growing dividends that haven’t been in as high demand, Katz says.
He thinks high-quality financial companies such as JPMorgan Chase & Co. (ticker: JPM) and Wells Fargo & Co. (WFC) offer attractive dividends at a discount. They also stand to make even more money and see their stock prices improve as interest rates increase, he says.
In energy, he says Chevron Corp. (CVX), Exxon Mobil Corp. (XOM) and Occidental Petroleum Corp. (OXY) have a safe and growing dividend and are selling at modest valuations. Plus, they have upside potential if oil prices increase over the next six to 18 months, he says.
Also in energy, Gradient recently bought contract oil and gas well driller Helmerich & Payne (HP), with Binger saying the company has a good balance sheet and a lot of room to appreciate as the energy market recovers.
Katz also likes health care stocks such as AbbVie (ABBV) and Pfizer (PFE) because they are at attractive valuations after getting beaten up by election rhetoric, he says.
Gradient last month bought stock in companies with histories of paying and raising dividends, that have a strong likelihood of raising dividends and qualify as blue-chip stocks, Binger says.
In addition to Helmerich & Payne, Gradient also found a bargain in Penske Automotive Group (PAG), which Binger felt had been unfairly punished because of Brexit worries. Even though the company has dealerships in the United Kingdom, its share pullback wasn’t reflective of fundamentals, he says.
Binger also likes the Extra Space Storage (EXR) story. The stock had been overvalued but then pulled back to what he thought was a great entry point.
[Read: Why Warren Buffett Loves Buy-and-Hold Stocks.]
And if the market as a whole does enter a 4 to 5 percent pullback in coming months, Binger thinks that could be a good time for investors to stock up on dividend-paying shares again.
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