In our Q4 Outlook report released last week, we highlighted the fact that while valuations for equities were high, there is case to be made that relative to alternatives, equities were attractively valued. The TINA (There Is No Alternative) argument, as it’s called, suggests that even with equities trading at rich valuations, they are attractive compared to yields on fixed income securities which are at or near historic lows. The fact that more than 60% of the stocks in the S&P 500 pay a higher dividend yield than the 10-Year US Treasury illustrates one example of this idea.
The problem with the so-called TINA argument is that when interest rates rise as they have this week, the alternatives can quickly start to look a lot less attractive. A case in point is the Utilities sector. Over the last several days, as the long end of the curve has steepened, high-yielding stocks like Utilities have been under steady selling pressure, and as of yesterday’s close the sector finished in the red for the tenth straight trading day.
Going back to 1989, the current ten-day losing streak for the Utilities sector is tied for the longest on record. As shown in the chart below, the only two other times the sector traded lower for ten straight days was in January to February of 1992 and August to September of 2002, so it is basically a once in a decade occurrence. Looking at the long-range chart, both of those periods proved to be pretty good long-term buying opportunities, but when we look at them in more detail, the ten-day streak did not correspond to an exact low. In the 1992 period, the sector declined another 3% over the course of the following two-months (to 4/8/92), while in the fall of 2002 the sector fell another 24% over the ensuing month (10/9/02) before it finally made its low. We would note that the 2002 streak coincided with a period of overall weakness in equities and in the aftermath of the accounting scandals of Enron and WorldComm, which were two of the worst accounting scandals in US history. With those events, you could understand why Utilities and utility-like stocks weren’t exactly viewed in the best light.
The basic takeaway from the recent decline in stocks typically known for their dividends is that stocks with high dividend payouts are attractive until they aren’t, at which point they can quickly fall out of favor. So when you are considering an investment in a dividend paying stock, if your only reason for the decision is because “it pays a good dividend,” you should probably look elsewhere. To this end, we take a different approach to dividend paying stocks in our Dividend Model Portfolio. Rather than focusing on the highest payers, we look at those stocks that have above average payouts relative to other dividend payers in their sector and have a history of consistently not only maintaining, but also increasing, their dividends. Additionally, the percentage of earnings that they pay out in the form of dividends has typically been low or at a reasonable level (less than two-thirds of earnings). Finally, in an attempt to avoid stocks that have high yields because of falling stock prices, we also incorporate a filter to weed out stocks that have been poor performers relative to the overall market.
Our Dividend Model Portfolio was launched in July 2014 and has returned 23.34% on a total return basis since inception compared to a total return of 14.39% for the S&P 500. To view the current makeup of the portfolio, become a client by signing up for a monthly Bespoke Premium membership and get 10% off for life ($89/month). (As always, past performance is not a guarantee of future results.)