The Crowded 3% Club

The 3% club is getting crowded: Dividend investors beware

Excerpt:

There is now an extraordinary crowding of big U.S. stocks around the 3% dividend yield level, a threshold that seems to exert a gravitational pull as investors bereft of easy sources of income bid up equities until they yield just a bit more than the 10-year Treasury note. (A stock's yield, calculated as the annual dividend payment divided by price, falls as shares climb.)

But too many investors may implicitly be betting that these bond-like stocks will act like stocks in a low-rate bull market, and like bonds in an equity downturn. It won’t likely work out that way. If the stock market remains strong, these are unlikely to be the areas that continue to thrive. If it hits the skids, such stocks will not offer much of a buffer.

Of the 422 stocks in the Standard & Poor’s 500 that pay any dividend at all, 58 of them now have yields within a narrow band between 3.3% and 2.7%. This roster spans virtually all industry sectors, with the expected over-representation of consumer-staples names but plenty of energy, real estate investment trust, industrial and healthcare entries as well.

Widened out a bit, almost a quarter of dividend-paying stocks in the index yield between 3.5% and 2.5%, including more than half of the members of the Dow Jones Industrial Average. Looking at a handful of stocks yielding almost exactly 3% shows how disparate their business trends and other valuation measures look. ....

Tobacco, personal-care products, utilities and REITs are all among the most richly priced. Rising-rate beneficiaries, in contrast, such as communications equipment, consumer- finance and autos appear inexpensive.

The investing site Magic Diligence, which uses the “Magic Formula” value-investing ideas popularized by hedge-fund pioneer Joel Greenblatt, this week offered interesting views showing that steady-seeming names such as Kraft Foods Group (KRFT) and Kellogg Co. (K) do not truly qualify as value stocks at all, in part because of their aggressive treatment of pension obligations.

Comment: My take is that the market is near the top. Must be cautious about investing.