DIVIDEND STOCKS MAY BE overbought. In fact, in the big rise since the market’s 2009 low, yields have dropped – and for your clients seeking dividend income, perhaps by more than they should have.
Your clients may now be receiving insufficient yields, given market and interest rate risk, after the 47% rise by the S&P/TSX composite index. In that period, dividends have increased by 24%, although earnings have risen by only 13%.
Among the industries that are the greatest dividend providers, yields relative to the broad market index have jumped sharply in the past year, and so have price/ earnings multiples.
Telecommunications services, for example, now yields twice as much as the S&P/TSX composite index compared with 1.5 times as much as recently as December 2011. The pipelines subindex (formally known as “oil and gas storage and transportation”) trades at 29 times earnings vs 16 in June 2011.
Dividend stocks and preferred shares are at risk from a rise in interest rates. When the Bank of Canada loosens the lid on short-term rates, the entire yield spectrum will rise. Already, long-term bond yields are edging higher, suggesting bonds’ 31-year bull market is ending.
A LEADING INDICATOR
The duration and extent of the market rise combined suggest caution. The market tends to run in four-year cycles, pointing to a low some time in the first half of 2013. And a 47% rise is a fair one for a bull cycle, although that has been outmatched by U. S. stocks, which have risen by 99% since the market’s recent 2009 low.
Utilities, the ultimate in dividend stocks, may be a leading indicator. They have tracked the broad market pretty well, relative to the S&P/TSX composite index. They are now at the level at which they were 20 years ago.
However, the S&P/TSX GICS utility subindex displays signs of weakness, including dropping volume, waning price momentum and several technical indicators that say “sell.” The most significant negative: promised dividend payouts now exceed earnings.
That said, the utility sector’s earnings in Canada are volatile. The one thing that keeps rising is total index dividends, typically increasing by 1% over six months, year after year. The current subindex’s yield is 4.8%, but the subindex trades at more than 50 times earninT: g9.s5.”
The pattern of higher payout ratios and higher relative yields continues through the utilities and pipeline sectors, as well as in the S&P/TSX’s dividend-specific subindices: the S&P/TSX dividend aristocrats and the newer S&P/ TSX composite dividend and S&P/ TSX equity income subindices.
YIELDS HAVE RISEN
Exceptions to the pattern are the banks and telecommunications. For both sectors, payout ratios have dropped as a result of recent increases in payments. Their yields relative to the S&P/TSX composite index have risen, however.
The oldest dividend-specific subindex, the S&P/TSX dividend aristocrats, has been running since 2008. In December 2010, the S&P/TSX equity income subindex and the S&P/TSX composite dividend subindex joined the list.
The yield on the S&P/TSX dividend aristocrats subindex has dropped to 4.3% from 5.3% in 2010; the payout ratio has risen to 80% from 43% in August 2011.
These three groups of long-term dividend payers account for 1% of the S&P/TSX composite index’s dividends but only 0.6% of earnings.
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