We’ve harped on about building streams of investment income for years now and the popularity of this trend has recently gained momentum. That’s led more than a few skeptics to wonder, “Is a dividend bubble forming?”
I’ve looked into this theory and my conclusion is “No.”
The most obvious evidence of a bubble is when the current value is far above a long-term average. I see no evidence of this phenomenon in a number of dividend-related measures.
Currently, the S&P 500 aggregate dividend yield is 2%. It was the same value, 2%, a year ago. And according to financial research firm FactSet, this is in line with the 10-year average.
Over the past 12 months, a total of $262.4 billion in dividends has been paid out. This figure has grown steadily over the past 10 years, but on a per-share basis of $28.40 we’re still well below the peak levels set in 2008.
If dividends were in bubble territory these figures would be far from their averages.
But the best judge of the sustainability of dividend payments is a measure called “payout ratio.” This measures the percentage of a company’s net earnings it uses to make dividend payments.
A little common sense goes a long way here. If a company is paying out 95% of its earnings as a dividend, it takes just a smaller stumble in profitability for the company to cut its dividend payment. On the other hand, a payout ratio of just 10% is easy for a company to maintain, even during leaner quarters.
Here’s a chart of the S&P 500’s aggregate payout ratio for the past 10 years:
As of the second quarter, the S&P 500 payout ratio was a healthy, sustainable 28.1%. This was in line with a payout ratio of 28% in 2011. It is even six percentage points below the 10-year average.
Companies have steadily increased earnings over the past three years and they’re rewarding investors in the form of dividend payments. If this was the tip of a bubble, I’d expect to see much higher payout ratios that look unsustainable in the long run.
As it is, I don’t see much cause for concern.
Of course, there are always lazy investors. These are the ones that hear “build streams of investment income,” and then rush out to find the stock that pays the absolute highest yield.
This is not a good strategy. Often, the stock with the highest yield can’t sustain the payment and suckered investors don’t realize this until it’s too late.
You can’t look at yield alone. Let a professional give you some guidance. EverBank Wealth Management’s Enhanced Yield portfolio is a great place to start.
If you haven’t done so already read the Survive & Prosper issue on “Looking for Yield in All the Wrong Places.“