Are Dividend Stocks Overvalued?

Using Morningstar's key dividend indexes as platforms, we explore valuation of high-yielding versus high-quality dividend-payers

Dan Lefkovitz 09 November, 2016 | 14:57
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Investors are in hot pursuit of income in the equity market, and the trend is evident in the asset flows numbers. According to Morningstar 2016 Strategic-Beta Landscape Report, dividend-screened/weighted ETPs are the most popular flavor of rules-based passive globally. In the U.S., they represent 27% of strategic-beta assets; in Europe 43%. Several actively managed U.S. equity funds with "dividend" in their names have bucked the trend toward passive, attracting significant flows.

But flows are often a contrarian indicator. Investors pile in after an asset class has run up, only to be disappointed. This leads to a persistent gap between total returns and money-weighted return as seen in Morningstar's Investor Returns data. So now is a good time to carefully consider the attractiveness of equity-income strategies. History teaches us that if valuations are lofty, future expected returns are likely to be modest. Are we, as some have said, in the midst of a dividend bubble?

Morningstar's key dividend indexes are useful platforms for analysis. The Dividend Leaders Index is a fairly focused cohort of high-yielding stocks screened on historical dividend growth and sustainability. The Dividend Yield Focus uses the Morningstar Economic Moat rating as a forward-looking gauge of dividend reliability and also employs the Distance to Default measure to screen for financial health. Both indexes are weighted according to available dividends and are U.S.-only. Dividend Leaders yielded 3.8% as of Sept. 30, 2016, while Dividend Yield Focus' yield was 3.6%. The Morningstar US Market Index yielded 2%.

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Dan Lefkovitz  Dan Lefkovitz is Strategist, Indexes Product Management. 

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