Investors fed up with rock-bottom interest rates and Treasury yields have piled into dividend-paying stocks, and dividend exchange traded funds outperformed the market by a wide margin last year. However, rich valuations in some dividend stocks and proposals to raise tax rates on dividends for high earners have some talking of a bubble.
So far this year, the nearly 8% advance in the S&P 500 has doubled the gains in many of the largest dividend ETFs, including Vanguard Dividend Appreciation (NYSEArca: VIG), iShares Dow Jones Select Dividend (NYSEArca: DVY) and SPDR S&P Dividend ETF (NYSEArca: SDY). [ETF Spotlight: SPDR S&P Dividend ETF]
Dividend ETFs have seen healthy inflows from conservative investors the past two years and plenty of media coverage after the subprime meltdown.
There’s an argument to make that investors are “running blindly, carelessly into dividend stocks today,” writes Morgan Housel at the Motley Fool.
Dividend ETFs are lagging growth stocks this year with investors turning upbeat on the economy and more comfortable a crisis in Europe can be averted.
“These are high-quality companies that deserve premium multiples. And there are exceptions to the rule. But for the most part, dividend-paying stocks are some of the most expensive and sought-after stocks in the market,” Housel points out.
Still, the Fed has pledged to keep rates low for the next three years, and the dividend payout ratio on S&P 500 stocks is near an all-time low, Housel notes. These factors could provide fuel to extend the rally in dividend ETFs. [Can Dividend ETFs Sustain Their Performance?]
“February is the busiest month for dividend declarations and increases, and this year, the biggest U.S. corporations may pay out a record amount, making up for some of the cash they withheld from shareholders during the financial crisis and earlier stages of the recovery,” CNBC.com reports.
Yet income investors moving from low-yield Treasuries to dividend stocks need to keep in mind they are taking on more risk in their portfolios, since equities are more volatile than bonds.
“Investors should also remember that dividend-paying stocks don’t always behave like other stocks, either,” the Wall Street Journal reports. “Dividend payers are often larger, established companies—which means they often aren’t perceived to have the same potential for earnings and revenue growth as smaller firms. When the rest of the market is booming, dividend payers are often lagging behind the crowd.”
Some claim the early underperformance of dividend ETFs this year is simply the result of portfolio managers pruning 2011’s winners.
“But nothing’s changed, professional investors say. U.S. large-cap stocks that pay a dividend remain as attractive as they have been over the past year,” writes Robert Holmes at The Street.
The Obama administration’s tax proposals include treating dividends as ordinary income for married couples making more than $250,000 a year and individuals making more than $200,000, Bloomberg reports.
Vanguard Dividend Appreciation
