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Dividends4Life (30.57)

Dividend Stock Bubble: Is It Even Possible?



March 13, 2012 – Comments (4) | RELATED TICKERS: MCD , MSFT , WMT

For the last 12-18 months Dividend Stocks have been on an upward spiral. Their ascent was propelled by low interest rates and the mass-media, infamous for stalking the next great fad. Following the well-worn script, the media cheerleaders are slowly swapping their pom-poms for darts as they assume their next roles as naysayers.

Recently, the news has devolved from 'everyone should own dividend stocks' to 'watch out, dividend stocks are in a bubble.' For the astute investor, one must first ponder the question: 'is it even possible for a dividend stock bubble to exist?' Let's explore this question...

Where's The Paradigm Shift? Think back to the Tech. Bubble and the rhetoric being spewed before it busted. You heard things like 'it's the new-normal' and there has been a 'paradigm shift' when experts tried to explain why ultra-high double-digit P/Es shouldn't alarm investors.

Where are the media experts saying high double digit P/Es on the leading dividend stocks are the 'new normal?' Oh, I guess the P/Es haven't quite reached ultra-high double digits.

Yield: The Ultimate Governor Why do people buy dividend stocks (Hint: They are not looking for unbridled growth)? Of coarse, investors  in dividend stocks are looking for income.

Q: What happens when the price of dividend stocks skyrockets?
A: Yield (and income) plummets for new investments.

When a dividend stock's price disproportionately increases and its yield declines, new investors will shy away and current investors will consider selling. This self-correcting mechanism will keep dividend stocks out of bubble-land.

Attractively Valued Dividend Stocks: Below are several big-name dividend growth stocks that are trading below their calculated fair values:

McDonald's Corporation (MCD) is the largest fast-food restaurant company in the world, with about 33,144 restaurants in 119 countries.
Yield: 2.8% | Discount: 1.9%

Colgate-Palmolive Company (CL) is a major consumer products company that markets oral, personal and household care and pet nutrition products in more than 200 countries and territories.
Yield: 2.5% | Discount: 2.0%

Hormel Foods Corp. (HRL) is a leading processor of branded, convenience meat products (primarily pork) for the consumer market.
Yield: 2.1% | Discount: 5.2%

Microsoft (MSFT), the world's largest software company, develops PC software, including the Windows operating system and the Office application suite
Yield: 2.5% | Discount: 13.4%

Wal-Mart Stores, Inc. (WMT) is the largest retailer in North America,Wal-Mart operates a chain of discount department stores, wholesale clubs, and combination discount stores and supermarkets.
Yield: 2.7% | Discount: 19.1%

Walgreen Co. (WAG) is the largest U.S. retail drug chain in terms of revenues, this company operates more than 8,000 drug stores throughout the U.S. and Puerto Rico.
Yield: 2.8% | Discount: 38.7%

Finally, if there was a dividend stock bubble and it popped would that be a bad thing? For the dividend stocks you held when the bubble popped, the income must have been at a sufficient level, otherwise you would have sold them and purchased another stock. If you liked the stock at $x, you should really like it at $x-$y. Buy quality, and don't be afraid to hold it.

Full Disclosure: Long MCD, CL, MSFT, WMT. See a list of all my dividend growth holdings here.

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4 Comments – Post Your Own

#1) On March 13, 2012 at 11:49 AM, outoffocus (23.19) wrote:

In the world of printed money and low interest rates, anything is possible.

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#2) On March 13, 2012 at 12:49 PM, constructive (99.97) wrote:

"When a dividend stock's price disproportionately increases and its yield declines, new investors will shy away and current investors will consider selling. This self-correcting mechanism will keep dividend stocks out of bubble-land."

You're assuming investors aren't idiots.  A dangerous assumption, often proved wrong.

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#3) On March 13, 2012 at 2:17 PM, constructive (99.97) wrote:

It's a question of degree.  High double digit PEs make catastrophic loss very likely.  High teen PEs make below average returns fairly likely.

I would rather buy a great company at a great price.  A 2% discount to my estimate of intrinsic value is nowhere near enough to interest me.

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#4) On March 13, 2012 at 5:57 PM, chk999 (99.96) wrote:

I think it is a good idea to keep track of the dividend yield versus the historical norm. If the current yield goes a lot below that, it is probably a good indication that the stock is overpriced. At that point I would sell at least half to lock in the gains. 

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