More Proof That There Is No Dividend Bubble

An article I wrote yesterday boldly stated that there is, in fact, no "dividend bubble." My fellow Fool Morgan Housel doesn't see it that way.

"I didn't quite agree with your reasoning," he messaged me. "For one thing, a lot of yields are at abnormal lows." He went on to cite the fact that Philip Morris International (NYS: PM) has an unusually low dividend yield, as do utility companies Consolidated Edison (NYS: ED) and Southern Co. (NYS: SO) .

Morgan is one heck of an analyst, but there was no way I was about to let him get away with shrugging this off based on a few anecdotal examples. It was time to gather some data.


On the whole
I'll start with one bit of evidence that could be seen as supporting Morgan's stance. If we look at the S&P 500 companies that had a dividend yield of 3% or more three years ago (bubble 1 in the chart below), the median price increase on those stocks has been 43.5%, and their current median price-to-earnings ratio is 18.2. Comparatively, among all stocks in the S&P 500, the median gain has been 37.9%, and the current median P/E is 17.4.

So the stocks that had a 3%-or-better dividend have outperformed the overall S&P and are currently trading at a higher price. The extent to which they've outperformed and the difference in valuation is hardly worthy of the title "bubble," but I don't want to completely deny Morgan here.

That said, it's a different story when we look at all of the companies in the S&P 500 that paid a dividend three years ago (bubble 2). That group has had returns in line with the overall S&P and has a current P/E ratio below the broader group. So it would appear that investors weren't simply after any dividends; they were going for higher dividends. And because higher dividends can often be a signal of undervalued stocks, perhaps all we saw with the group that outperformed the S&P was the fact that they started the three-year period undervalued.

More importantly...
A key to the argument in my article yesterday was that because dividend yields fall as stock prices rise, any sort of dividend bubble would cool itself down as rising prices pushed down yields.

And so when we talk about the potential for a dividend bubble, we should consider the stocks that investors would be looking at today because of their yields. Interestingly, among the stocks that currently sport dividend yields of 3% or better (bubble 3), the median P/E is 16.3, notably below the 17.4 of the overall S&P. Furthermore, over the past three years, that group has had a median return of 26.4% versus the overall S&P's 37.9%.

So in essence, the investors going after significant dividend yields don't end up picking crazed, inflated stocks, but stocks that look more like value-oriented picks. And that's in addition to the fact that they pay attractive dividends.

What about Philip Morris?
I can't really argue with the examples that Morgan provided. Yes, the yields do look somewhat low on Philip Morris, Con Ed, and Southern. But what does this tell us? Not a whole lot. Based on the data above, I hardly think we can conclude that there's a dividend bubble. In fact, it's hard even to conclude that there's a bubble in utility stocks or consumer staples stocks.

Over the past three years, utility stocks as a group (bubble 4) have underperformed the S&P, and they trade at a P/E that's a discount to the rest of the index. Sure, Con Ed has had a stellar run -- a 46% gain that has pushed its P/E close to 17 -- but PG&E has vastly underperformed the market, and its dividend yield has risen over the past three years. And the fact that Exelon paid a 4.2% dividend three years ago didn't save its stock from a 29% slide.

There are also some good examples on the consumer staples side. Philip Morris is up a whopping 90%, and its yield has fallen from 4.9% to 3.8%. On the other hand, Clorox has risen just 23%, and its dividend yield has climbed from 3.4% to 3.6%. Meanwhile, Procter & Gamble's stock is up just 20%, and its yield is up as well.

So where's that bubble again?
Over the past three years, 78% of the stocks in the S&P 500 have seen their prices rise. The median price gain has been 38% (45% on average). That means that many of the stocks we might look at have had solid performance over the past three years. Some of those stocks are dividend payers. So, yes, it's entirely possible for us to find certain dividend stocks that have gone up significantly in price and are not attractive buys today. But does this mean that we have a dividend bubble on our hands? Not so much.

If you think that I'm right and Morgan is wrong about this dividend bubble, I commend you for your shrewdness and wisdom. As a show of my appreciation, follow this link to get free access to a Motley Fool special report that dives into nine dividend-paying stocks that could be ready for prime time in your portfolio.

The article More Proof That There Is No Dividend Bubble originally appeared on Fool.com.

The Motley Fool owns shares of The Clorox Company. Motley Fool newsletter services recommend Exelon, Southern Company, and The Procter & Gamble Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Fool contributor Matt Koppenheffer owns shares of Clorox but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

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