It's time investors stopped worshiping at the altar of dividend stocks, and started weighing whether they are truly as low-risk as they used to be.
I like juicy yields as much as the next guy, since I personally lean towards buy-and-hold investing for the long-term with reinvested dividends.
But frankly, the constant drum-beating around the power of dividend payers gets on my nerves.
It's about time investors stopped worshiping at the altar of dividend stocks, and start thinking seriously about the relative risk of dividend stocks -- and more importantly, whether this particular corner of the equities market is truly as low-risk and income-rich as it used to be.
The appeal of dividends is undeniable, especially in this low-rate environment where there simply aren't any interest-bearing assets. And it's undeniable that many retired Americans are in a financial situation where income via reliable dividend payers makes a lot of sense.
But if you need proof of just how fashionable -- or darn near bubble-like -- income investing is, just consider that the newly created Retirement Income Certified Professional is the hottest designation for financial advisors in the 87-year history of the American College of Financial Services.
When fee-based advisors are clamoring to be experts in a given discipline in order to get in front of more customers, that tells you something.
The popularity of dividend stocks over the last few years is obvious, and has resulted in a seismic shift in valuations for this once-sleepy sector.
As Mebane Faber of Cambria Investment Management recently pointed out, dividend stocks that normally trade at a deep discount to the broader market are now trading for a significant premium. Consider that in 1997, the price-to-earnings ratio (P/E) of defensive sectors characterized by dividend payers was sometimes as much as 40 percent below the relative P/E of the broader market . . . but in 2013, defensive dividend payers are trading for a 20 percent premium.
So much for low-risk investments if you're paying a higher relative earnings multiple than the other stocks on Wall Street.
Interestingly enough, despite this expansion in valuation multiples, there has been a simultaneous contraction in dividend payout rations. Every dividend investor knows this -- with dividends going from about three-quarters of corporate profits around World War II to about 50 percent in the 1970s and 1980s to roughly 30 percent after the damage of the Great Recession.
There are a host of items to blame for this trend. There's the rise of tech stocks like Apple (AAPL) and Cisco (CSCO) and Oracle (ORCL) that make up a large part of the S&P 500 Index ($INX) now, but up until recently haven't paid a dime . . . and remain miserly with their payout ratios even after instituting a dividend. There's also the general sense that corporations are hoarding their profits instead of distributing money to shareholders, with non-financial stocks now sitting on over $1.5 trillion in cash and investments.
But any way you slice it, dividends aren't what they used to be as a share of the profits.
Josh Brown over at The Reformed Broker shared a Merrill Lynch tidbit recently that pointed out the change in beta across market sectors. And surprisingly, the beta -- roughly translated as "volatility" to those who don't know their Wall Street Greek -- of historically low-risk sectors like telecoms, staples and utilities has been on the rise. On the other hand, historically cyclical and volatile sectors like materials and financials are seeing their beta readings fall.
In plain English, this means that what you thought of as sleepy stocks are now supercharged -- with the ability to deliver big outperformance or underperformance, depending on the environment.
And forget about beta -- what about alpha, or the ability to move in opposite of the broader indexes instead of marching in the same direction? Consider 2011, where the broader S&P index and the Utilities SPDR ETF (XLU) put up 14 percent returns in calendar 2011. Or more recently in the last three months, where supposedly bulletproof blue-chips AT&T (T) and Procter & Gamble (PG) have been fighting just to break even while the broader S&P 500 is sitting on almost 3.5 percent gains.
Not exactly your grandad's slow-and-steady dividend stocks, eh?
Income is nice, but if you are exposing yourself to massive capital risk in dividend stocks then perhaps you need to reconsider your definition of low-risk investing.
These are uncomfortable realities of dividend investing in the wake of the financial crisis, as well as the harsh truth of what it's like to seek income under the yoke of a Federal Reserve funds rate that is effectively zero.
The volatility is up, the dividends are down and investors are paying a premium for this risky combination.
But what are the alternatives? Even if inflation remains low enough for the meager returns on Treasurys and corporate bonds to keep pace with inflation, that's cold comfort for those investors who still need to grow their funds instead of just bleed them down to live off of.
And furthermore, even if you are comfortable with 0.9 percent in a "high yield" CD, a good investment portfolio is always diversified to have some equity exposure -- and like it or not, dividend-paying blue-chips remains the go-to asset of choice.
It is obviously an overreaction to say we are witnessing the death of dividend investing, since we will always have corporations that deliver cash back to shareholders in some manner and there will always be a place for these stocks in a good investing portfolio.
But it is not too crazy to posit that we could be witnessing the end of low-risk dividend investing.
Because even if companies keep dishing out the dividends, unless the premium paid on income stocks or the low payout ratios begin to reverse course, this corner of Wall Street has dramatically changed over the past few decades.
And certainly not for the better.
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