The past year has seen a spectacular run for steady dividend-paying companies and other “defensive” stocks.
How good? Well, just look at the movement of exchange-traded funds like the iShares Dow Jones Utilities ETF (NYSE:IDU) and iShares Dow Jones US Consumer Goods ETF (NYSE:IYK) — both up 17% in the past year, outpacing the S&P 500‘s 14% returns — or the iShares Dow Jones US Telecom ETF (NYSE:IYZ) and its 23% gains.
So, why the flood?
- Yields on money market funds and CDs are laughable, and Treasuries just aren’t as appetizing as the other alternatives right now. Those “other alternatives” include high-yielding dividend stocks (though also junk and other bonds).
- The economy is improving, but only at a snail’s pace — and that tepid growth has investors still seeking out the relative safety of stodgier blue-chip dividend stocks.
- Many companies are flush with cash, and shareholders know it — and in turn are demanding more of that cash in the form of dividends (and buybacks).
Of course, the downside of such an influx of investor interest is that many of Wall Street’s more ubiquitous dividend payers are sitting at relatively high valuations — in many cases, despite showing lagging revenue and earnings growth rates.
The following 10 dividend-paying giants who might be getting a little ahead of themselves. All 10 …
- Have outperformed the S&P 500 year-to-date
- Are trading above the S&P 500 average trailing 12-month P/E of 18
- Are forecast to grow earnings slower than the expected S&P 500 average profit growth rate of 8%
A few stocks stand out more than others, of course. In the case of Merck and Bristol-Myers, it’s difficult to justify any kind of high P/E amid expectations for earnings contraction. Meanwhile, Coca-Cola (NYSE:KO) only barely makes this list — it might be a bit overpriced, but not so much that investors should be fleeing it in droves in fear.
But broadly speaking, these defensive stocks are priced more like growth stocks despite below-average growth expectations (and in many cases, poor recent history of revenue growth). For comparison’s sake, Google (NASDAQ:GOOG)’s P/E of 24 is right in line with Pfizer (NYSE:PFE) and Johnson & Johnson (NYSE:JNJ), but has far more robust earnings growth expectations of 18% for the current year.
There’s no mystery to this phenomenon. Investors clearly are jumping into the safety camp — maybe they’re scared that tepid U.S. economic expansion is bound to catch up to the market, that global sluggishness will rear its ugly head on more growthy stocks … heck, maybe they’re scared of “sell in May” taking hold.
In such an environment, these kinds of stocks — blue chips with big, reliable dividends — are the most obvious security blanket. And when everybody ducks under that blanket, you get the lagniappe of increasing stock prices, providing investors with the best of both worlds.
But while their dividends help ease the pain of a flat or receding market, high levels of froth can bite back when the going gets good. Should the U.S. economy (and other major economies, for that matter) heat up, we’ll likely see this all play out in reverse — many investors will register their profits and head to more aggressive stocks. And should interest rates rise, so too will investor interest in fixed-income securities.
So what’s an investor to do?
Tread lightly — in both directions. While these frothy valuations don’t mean you should abandon ship on long-term positions in these stocks, it does mean you shouldn’t look to initiate or add to positions at this time.
If you’re still itching for action, look for more fundamentally promising stocks that aren’t so highly priced. Otherwise, if you’re just hoping to get into any of the aforementioned names (or similar companies), consider waiting for a better entry point.
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing he is long JNJ.