Look Beyond Dividend Yield

4/25/2016


With the major U.S. averages near all-time highs, U.S. stocks appear expensive relative to historical norms on nearly all valuation metrics.

The big exception is dividend yield. The median yield for stocks in the S&P 1500 is 1.4% — well above the norm of 0.8% since 1994, and higher than 98% of month-ends since 1994. Median yields have also risen above historical norms for the large-company S&P 500, S&P Midcap 400, and S&P SmallCap 600.


Medians for S&P 1500 stocks

Price/
Earnings
Ratio
Price/
Cash-Flow
Ratio
Price/
Sales
Ratio
Dividend
Yield
(All Stocks)
Dividend
Yield
(Excludes
0% Yields)
Current median
19.9
13.8
1.7
1.4
2.2
Norm since Oct. 1994
18.0
11.5
1.3
0.8
1.9
Recent as % of norm
111
120
129
173
116
% of months lower
than recent since '94
85
94
92
98
87

By comparison, median price/earnings, price/sales, and price/cash-flow ratios for all four indexes have soared at least 10% to 25% above historical norms — and higher than at least 85% of month-ends since 1994.

Today's dividend yields look even more attractive relative to the measly yields available from bonds. Why buy a bond yielding 2% or 3%, many argue, when plenty of quality stocks offer similar yields and the potential for dividend growth?

While this is a question worth asking, it's potentially misleading, for several reasons:

• First, the different risk profiles of stocks and bonds make simple comparisons based on yield misleading. A bad year in the U.S. investment-grade bond market can result in a loss of 5% to 10%. A bad year in the U.S. stock market can bring losses of 30% to 45%.

• Second, using dividend yields as your sole measure of value is problematic, as companies have discretion when setting their dividend policy. Today, partly because companies realize investors are desperate for income, they pay out a larger portion of their earnings as dividends. As a result, payout ratios (indicated year-ahead dividends as a percentage of trailing 12-month earnings) have risen near 20-year highs for all but the highest-yielding stocks.

• Third, higher-yielding stocks look expensive, as shown in the table below. Based on price/earnings, price/cash-flow, and price/sales ratios, higher-yielding stocks are more expensive relative to 20-year norms. Consumer staples and utilities — sectors prized for their dividends and stability — are unusually expensive relative to the broad market.

• Fourth, with so many investors clamoring for dividends, the value-minded may want to look for bargains among low-yielding stocks with superior fundamentals. Among Focus List stocks, Alaska Air ($82; ALK), Amerco ($353; UHAL), Lear ($113; LEA), and Owens Corning ($51; OC) have yields below 1.5%, Quadrix Value scores of at least 70, and Overall scores of at least 90.

Versus history, higher-yields stocks expensive
For the table below, we divided dividend-paying S&P 1500 stocks into five equal-numbered groups. We also looked at stocks lacking dividends. Relative to historical norms, stocks with high yields are the most richly valued. For example, the two quintiles with the highest-yielding stocks have price/earnings ratios higher than at least 81% of month-ends over the past 20 years. None of the other groups is higher than 78% of month-ends.
Yield
(%)
Payout
Ratio
(%)
P/E
Ratio
Price/
Cash Flow
Price/
Sales
NO DIVIDEND
Current average
0.0
0.0
26.6
18.2
2.4
20-year norm
0.0
0.0
24.6
16.5
2.5
Recent as % of norm
Not
108
110
95
% of months below current
Meaningful
76
81
40
LOW YIELD (BOTTOM QUINTILE)
Current average
0.8
19.0
24.5
17.5
2.4
20-year norm
0.5
12.0
22.3
15.0
2.2
Recent as % of norm
144
159
110
117
111
% of months below current
95
100
78
93
79
BELOW-AVERAGE YIELD
Current average
1.6
30.1
20.6
15.1
2.1
20-year norm
1.2
23.5
20.2
13.3
1.7
Recent as % of norm
127
128
102
113
120
% of months below current
93
100
56
85
89
AVERAGE YIELD
Current average
2.2
38.4
19.8
15.2
2.2
20-year norm
1.9
32.4
19.0
12.3
1.6
Recent as % of norm
117
119
104
124
139
% of months below current
90
99
65
99
97
ABOVE-AVERAGE YIELD
Current average
3.0
52.9
21.9
13.8
3.2
20-year norm
2.8
42.7
18.6
11.4
1.8
Recent as % of norm
105
124
118
121
182
% of months below current
71
100
96
99
100
HIGH YIELD (TOP QUINTILE)
Current average
4.9
48.2
20.3
12.3
3.2
20-year norm
5.1
53.9
18.4
9.6
2.0
Recent as % of norm
97
90
110
129
159
% of months below current
57
2
81
93
90

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