In today’s highly uncertain market environment, investors in US stocks are paying a premium for companies with high-dividend yields. But how much is too much—especially if interest rates stop declining? Stocks with resilient high-growth profiles deserve a closer look.
The hunt for yield continues to create market distortions. While the price/forward earnings (P/FE) ratio of the S&P 500 is close to its long-term average, sector valuations look imbalanced. Stocks that are sensitive to interest rates and yield are being pushed up as the 10-year US Treasury yield has dropped back down below 2%. At the end of August, most US sectors with dividend yields higher than the S&P 500 traded at a hefty premium to their long-term averages. In utilities and real estate, where investors can find juicy dividend yields above 3.2%, the sectors are at least 30% more expensive than the 20-year average of their P/FE ratios. Energy is the only outlier, as high-dividend yields have been buoyed by sharply falling shares amid a weak oil price.
On the other side of the spectrum, sectors like healthcare, technology and communication services trade at discounts to their long-term P/FE averages. Their dividend yields might not be as alluring, but are the fundamentals in these sectors really as weak as the discounts imply?
Search for Sources of Secular Growth
To answer that question, you need to look at individual stocks and companies. In a world where macroeconomic growth is expected to weaken and aggregate earnings growth for the market has slowed to the low single digits, grabbing for yield at any price isn’t the solution in our view. And if the drop in yields reverses, as it did in early September, these overvalued sectors could decline significantly.
Instead, we prefer to search for companies with solid sources of secular growth that can be maintained even in a more challenging economy. Of course, some companies like these can be found in more expensive sectors. But the current valuation gaps suggest that equity candidates with long-term growth potential can be found in unloved sectors at attractive prices.
- James T. Tierney, Jr.
- Chief Investment Officer—Concentrated US Growth