What a difference a decade makes. At the beginning of 2000, if you mentioned that you should be buying high dividend paying stocks at a cocktail party, you would have been laughed at as a complete idiot. Now, many pundits advocate buying mega cap, dividend paying stocks. These stocks are also being touted as a safe alternative to bonds and cash. Are they?
Let’s look at what type of companies pay dividends. These are usually large, mature companies with a significant portion of their revenue generated overseas. Europe’s problems and a rising dollar are a major headwind for these companies going forward. They typically pay out a nice dividend. Why? Because management cannot reinvest earnings back into the company at a reasonable growth rate, and thus, it makes more sense to return the money to shareholders through dividends. For this reason, high dividend paying stocks tend to not grow as fast as non-dividend paying stocks. That is why those stocks tend to sell at a discount (as measured by the price/earnings ratio or P/E ratio) to faster growing companies.
Presently, however, dividend paying stocks are selling at their highest valuation to non-dividend paying stocks since 1975. Please see the chart below. The time to buy dividend paying stocks was at the beginning of 2000, not today. Moreover, with the tax rate on dividends scheduled to rise from the current 15% rate to 43.4%, dividend paying stocks become even less attractive.
Last week, Mario Draghi, head of the European Central Bank, mentioned that he will do anything to save the Euro. After that comment, the market rose. Many people assumed this comment meant that the ECB would be buying sovereign debt in Europe. We find this hard to believe as Northern Europe – including Germany, Finland, Belgium and the Netherlands – is against the ECB buying the debt of Spain and/or Italy. We have heard this from European leaders before. In our opinion, it is just another head fake to help Spain sell bonds at lower rates over the next few months.
So what does this mean for the market? The perceived safest part of the market could be the worst performing investment over the next few years. Investors should be careful buying large company stocks paying high dividends. Don’t be fooled by the ECB’s position. It was less than a week ago that protestors were out in droves in Spain protesting against austerity. The time is coming to be more aggressive with your money – it may occur in the next few weeks or months. We are prepared to make investments in undervalued assets in order to benefit from the next move up in the market when the risk to investing has dissipated.
Your THOR Team