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By Jeremy Glaser | 02-08-2012 01:00 PM

Peters: No Dividend Bubble

Dividend-paying stocks are fairly valued, but low payout ratios indicate that there could be more room for dividend growth, says Morningstar DividendInvestor editor Josh Peters.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Morningstar DividendInvestor editor, Josh Peters, to see if there is a bubble in dividend-paying stocks.

Josh, thanks for talking with me today.

Josh Peters: Good to be here. Can't believe people are throwing the B-word around in my sandbox. This is really unusual.

Glaser: Yes. It's not an area of the market that we generally talk about. There's rampant speculation. But with a lot of investors looking for yield, there has been some talk that there is a bit of a bubble, that people are throwing money into anything with just a little bit of extra yield and maybe not thinking about valuation. What's your take on the general level of valuations of dividend stocks, right now?

Peters: I think, the word bubble really doesn't work well for dividend-paying stocks because if you go into the market, you're looking for a high yield. As the price goes up, the yield comes down, until the stock isn't even a high-yield stock anymore. So, people focusing on dividend yield, I think, is actually a good pressure-relief mechanism because as the price goes up, you're getting that lower yield. It's telling you that the stock is becoming less and less attractive as it goes along. For a bubble or this sort of vertical-type of price behavior, I'm not seeing that. Dividend-paying stocks, high-payout stocks, and high-yield stocks had good absolute returns and very good relative returns last year, but they didn't move into what we think of as overvalued territory as a whole.

That said, some areas of the high-yield market do look pretty expensive. REITs, I think, right now are quite expensive. Typically you would expect to see a REIT yielding at least 4% or 5% even in a low-interest-rate environment. Just throw to out one name, Public Storage, ticker symbol PSA, which operates of self-storage facilities, yields only 2.75%. It's overvalued enough to get a Morningstar Rating for stocks of 1 star relative to our fair value estimate. There's a case where I think that people's interest in yield, their interest in real estate, and their interest in defensive cash flows has really, really inflated the price of the stock beyond what we think it can support going forward.

Regulated utilities, especially the fully regulated firms that don't have any energy market or commodities exposure of any meaningful extent, also look pretty expensive. Piedmont Natural Gas actually was one of my favorite utilities from a fundamentals standpoint. I think it's very well run, it's got great regulatory relations, it's got a good geographic footprint, and it has a terrific record of dividend growth. But when I see a stock like that yielding only 3.5%, you're just not going to get the kind of growth that can make up for that kind of a yield and actually generate a good 9%-10% total return over time. And Piedmont is another stock that earns a 1-star rating. So, there are some areas where I think we're looking at some overvaluation. But on a whole, I would describe the high-yield universe as being fairly valued.

Glaser: Even if we're not seeing ridiculous valuations in high-yield stocks, do you think that there is a bubble, so to speak, in allocations? For example, investors who were previously focused on fixed income but are seeing very low yields in that sector are now moving into dividend stocks, but maybe they aren't totally aware of the risks that are inherent in owning those equities?

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