Analyst: Avoid “Dividend Darlings” with High Valuations
Debt Investors Shifting Money to Dividend Stocks
New York, NY — Yield-hungry debt investors shouldn’t blindly buy dividend stocks with high valuations.
Investors are diverting cash to equity markets as they look for returns amid negative yields in most of the developed world and falling returns on corporate bonds. These investment flows have helped the S&P 500, Dow Jones Industrial Average, and NASDAQ Composite to hit new record highs, especially at a time when there are no major inflationary pressures and central banks are willing to sit on the sidelines for a longer period of time.
“If you are going to add new money to the market, I would be very careful not to do it in those dividend darlings—so things like utilities and consumer staples and telecoms…because I feel like that is a very crowded trade,” says Art Hogan, director of equity research at Wunderlich Securities. (Source: “Equities are the new bonds—but avoid the ‘dividend darlings’,” CNBC, August 18, 2016.)
Strategists at Morgan Stanley (NYSE: MS) don’t see interest rates going up until 2018 as global growth, particularly in the U.S., will be disappointing over the next 12 months. The bank sees the U.S. economy expanding by 1.5% in 2017, while the consensus view is 2.3%. (Source: “No U.S. rate hike until 2018,” MarketWatch, July 18, 2016.)
While investors park their funds in defensive dividend-paying stock, Hogan cautioned that these “dividend darlings” are expensive to own.
This ongoing search for yield is one of the main contributors to the impressive performance of several defensive stocks with steady income streams.
For example, shares of Johnson & Johnson (NYSE:JNJ), Kraft Heinz Co. (NASDAQ:KHC), and International Business Machines Corp. (NYSE: IBM) all posted double-digit gains in the past three months. These are some of the solid dividend-paying companies and included in the portfolio of Warren Buffett, a billionaire investor whose skill at picking stocks has earned him an unprecedented reputation among investors.
Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.A) increased its bets on some of its dividend-paying stocks earlier this week, including Buffett boosting his stake in Apple Inc. (NASDAQ:AAPL) to approximately $1.5 billion in the second quarter. (Source: “Buffett’s Berkshire Hathaway Increases Bet on Apple,” The Wall Street Journal, August 16, 2016.)
An investing strategy where you look for growth instead of yield is probably a better one than simply focusing focusing on defensive stocks. Hogan suggested that investors avoid companies with earning multiples as high as five times above the average and yielding about 200 basis points below the average.
“I would be much more comfortable putting it in growth than defensive right now,” he said. (Source: Ibid.)