Jeremy Glaser: I'm Jeremy Glaser at Morningstar.com. With interest rates at near zero percent and even long term CDs not looking terribly attractive from a yield perspective, a lot of investors are looking at dividend-paying stocks as a way to boost short-term yield.
Here to discuss this with me is editor of Morningstar DividendInvestor, Josh Peters. Josh, thanks for joining me.
Josh Peters: Happy to be here, Jeremy.
Glaser: What do you think about investors chasing a stock like AT&T for a 6% yield now, versus looking at Treasury bills?
Peters: You would think if I'm editing a newsletter called DividendInvestor I have to be excited that people are taking more interest in dividends again. But the fact of the matter is that you really don't want to get into the business of looking at stocks as a way to juice your income over the short term.
There is really no useful comparison between having a one-year CD and owning 100 shares of AT&T. You own each of those types of investments for very different reasons. If you start thinking in terms of AT&T just has higher income right now than that bank CD has, you might find yourself disappointed with the amount of risk that you're taking in order to get those couple extra percentage points in yield.
Glaser: Investors really need to keep in mind that stocks are still a different asset class than necessarily holding cash.
Peters: Yeah, that's very, very true. The decision to own cash, most of the time is going to be an asset allocation decision or a personal financial decision. You don't want to look at your cash holdings as a way to generate a lot of long-term income or long-term total return. And even if the cash yield is zero, don't think in terms of getting rid of your cash and chasing yields elsewhere. You might be unhappy with the amount of risk that you take.
Glaser: Have you seen, over the last couple of weeks, or couple months, there has been a trend of people moving into short-term stocks?
Peters: It certainly seems like there is a bit of an emerging trend in that direction in part. I've seen other media reports suggesting that instead of dividend-paying stocks continuing to underperform it is now investors looking for yield and dividends, and dividend-paying stocks starting to outperform. The market has kind of leveled off here over the last month or so, but dividend-paying stocks are starting to catch up, scoring increases on a market that is kind of flattish.
Those are generally good signs, and we have seen some of the biggest dividend-paying stocks, like AT&T, Merck or Bristol Myers, Eli Lilly, Verizon, companies like those, their share prices are starting to do much better relative to the market as a whole.
Again, I want to caution people, don't think in terms of dramatically reshaping your portfolio in order to get a little more income right now. In particular, some of the stocks that have really been leading this trend toward dividend-paying stocks are not the ones that I would necessarily buy for total return.
At very low dividend growth prospects, their yields are better than S&P average, better than long-term Treasury bonds even. But if you are not going to get growth from a stock, dividend growth, earnings growth, valuation growth, then that yield, even if it is 5%, 6%, 7%, gets to be much harder to justify.
Glaser: What is the impact of this trend on long-term dividend investors?
Peters: I think that, again, there's kind of a mixed blessing that goes on. For somebody like me who wants as many people to be interested in dividends as possible, it is great. But I tend to think in terms of wanting to have lots of bargains, wanting to be able to go out in the marketplace and find a lot of bang for my buck in the dollar. Both whether I'm putting new money to work or if I'm reinvesting dividends.
I think one of the great lessons of the Phillip Morris story, now Altria Group, over the years is that the stock tended to be undervalued all the time. Which meant that you were receiving a bigger dividend yield then you would have if the stock price had been higher, in order to reflect the real prospects of that business.
And you then could take that higher-than-average yield and reinvest it in more undervalued shares. And you could compound your income and your wealth much faster because the stock was undervalued.
So just because dividend-paying stocks are going up isn't necessarily a reason to rejoice. But to the extent that it is reflecting more confidence in the marketplace and the underlying fundamentals of what I think are some very good dividend-paying businesses, like a Johnson & Johnson, or an Abbott Labs, some utilities like NSTAR, Westar Energy, some of my favorites, then I like to see that affirmation. But again, it kind of falls into the realm of the mixed blessing.
Glaser: Certainly the Fed is not going to be able to keep interests rates at zero forever. Do you think that when the interest rates start to rise, are we going to see a flood of investors moving out of dividend stocks and back into money market funds?
Peters: It is possible. The way I think about it is that you have two countervailing forces. For right now the economy is still very weak, you don't have a backdrop of economic growth that is going to drive corporate earnings growth and stock prices higher, but you do have very low interest rates.
If the economy starts to improve, chances are interest rates go up. For some sectors in the market, earnings will go up faster perhaps then interest rates will and net on net you will be ahead. But traditionally your dividend-paying stocks don't have that much to lose in a downturn but they also don't have that much to rebound from then when the cycle turns up.
I think you have to keep your expectations under control. We're probably not going to see a huge bull market in dividend-paying stocks if the economy does enter a more vigorous recovery.
If it doesn't, though, then interest rates stay low and dividend yields look that much better by comparison for a longer period of time. It's actually a formula for relative stability. I don't think you're going to see a huge amount of share price appreciation. I don't think you're going to see wild dividend growth either because you just don't have the earnings expansion and economic expansion to back it.
But I think there are still a few stocks out there in the market that you can buy today for relatively reliable predictable income and total return. You want to get the income and the growth. You don't want to buy just yield or just growth alone.
Glaser: Obviously very hard to predict the future, but it certainly looks like long-term investors can still look for dividend-paying stocks. They can see that total return story, but people looking for short-term yields may want to accept those lower yields elsewhere because they might be taking on risks that they aren't even aware of.
Peters: I think a good rule of thumb is that if you know you're going to need this money within five years, maybe you know you're going to buy a new car with it, you know you're going to have to make tuition payments for your kid, or something like that, don't put it in the stock market.
If you're willing to make an almost indefinite commitment of money, let's say as part of a retirement portfolio that you could be owning for 10, 20, 30 years, then the trade-off of moving your money into a more volatile asset like a common stock makes sense.
You're going to get the dividend return, hopefully some good dividend growth, good overall total return. In this context you're not betting against the clock that, "I hope this thing is worth more than I paid for it by the time I need the money." That's really not the kind of bet any investor wants to make with money they know they're going to need.
Glaser: All right, great. Thanks for talking with me today, Josh.
Peters: Happy to be here.
Glaser: For Morningstar.com, I'm Jeremy Glaser.