INSIGHTS

On September 12, 2016

AAM Viewpoints - Are Dividends Overbought?

A major theme in 2016 has been the resurgence of value stocks and specifically dividend paying equities. Year to date, the Dow Jones Select Dividend Index (DJDVY) has a total return of 17.99%, more than double the total return of the S&P 500 (SPX) of 8.60% (as of 9/6/2016). The run on dividends has caused some concern that the space has become overbought. We do not see an overbought condition, rather further proof that dividends were over-sold in 2015. The chart below breaks the S&P 500 into groups based on dividend yield and shows the price return of the groups in 2015.

Past performance is not indicative of future results.

Source: FactSet

There was a clear relationship – the higher the dividend yield, the lower the price return. Non-payers outperformed the highest payers by over 26% on a price basis and 22% on a total return basis.

Since the February 11, 2016 lows, the DJDVY and the SPX have a total return of 20.70% and 20.82% respectively; a difference of only 13 basis points. The outperformance of dividend paying equities in 2016 came entirely during the first six weeks of the year amongst historic volatility. The rough start to the year was a catalyst for the dividend space that we feel was unreasonably punished in 2015 and set the table for the resurgence in 2016. Now the question becomes, “Can dividend payers hold on to their gains?”

Traditional valuation measures such as price-to-earnings and price-to-sales suggest the DJDVY is trading at rich valuations and we would expect a reversion to historic multiples. However the reversion doesn’t have to come in the form of a price decline. According to Bloomberg aggregate analyst estimates, the DJDVY is expected to grow earnings per share by 10.44% over the next 12 months. Revenues are expected to grow 4.77%. If the denominator in the valuation multiples can increase over the next year dividend paying equities would be fairly valued on a forward looking basis and could sustain current levels.

On a relative basis, the current dividend yield of the Dow Jones Select Dividend Index of 3.63% offers a spread to the 10-year U.S. Treasury of 2.09% compared to the five and 10-year average spread of 1.69% and 1.21% respectively. This suggests that compared to Treasuries dividend paying equities are cheap and could sustain current levels.

We believe the use of dividends as a bond alternative is something that should not be overlooked. Not only are dividends offering an attractive spread, but dividends per share for the DJDVY are expected to grow 3.26% over the next 12 months; much greater than the rate of inflation. The prolongation of low – and even negative – interest rates globally will continue to highlight the opportunity in equity income.

Add it all up and we believe the case for dividends remains strong. We do not see an overbought environment in the space, if over the next 12 months earnings and revenues can grow as estimated and interest rates remain depressed. If so, we believe dividend-paying equities could be positioned not only to sustain current levels but to move higher from here.

CRN: 2016-0901-5532R

Dividends are not guaranteed and will fluctuate. Dividend yield is one component of performance and should not be the only consideration for investment.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com.