A bubble in dividend stocks?

Since the start of the financial market recovery four years ago, dividend-paying stocks have been in high demand.  As the recovery gained traction in 2010, big dividend payers were especially sought after by investors and were given preference over growth stocks and tech shares, which have historically been the big leaders in bull markets. 

Income hungry investors became disillusioned with low-yield Treasuries and instead turned their attention to companies with higher than average dividend yields.  A multitude of books and articles on dividend investing in the last couple of years have only increased investors’ appetites for such stocks. 

It was somewhat surprising to learn that the securities of longtime steady dividend payers in the S&P 500 have outpaced the price gains in the S&P index itself.  According to Alexandra Scaggs, writing in the April 1 issue of Barron’s, while stocks haven’t actually recovered from the financial-crisis lows on an inflation-adjusted basis, “dividend payouts from the S&P 500 have more than kept pace.” 

According to research from Howard Silverblatt, senior index analyst with S&P Dow Jones Indices, dividends grew 14% from 2007 through the end of 2012, outpacing inflation.  Moreover, dividend-paying stocks have also seen worthwhile gains in share price, as Scaggs points out.  The so-called Dividend Aristocrats have made a 144% recovery from their financial crisis lows.

So what does it all mean?  While it would be tempting to jump to the conclusion that there is a “bubble” in dividend stock investing, I wouldn’t go this far.  Demand for dividend payers is reaching a level that suggests they’re close to the point of diminishing returns, however.  As more and more investors jump onto the dividend bandwagon, ignoring technically stronger market segments in the process, the stodgy dividend payers will surely be unable to continue meeting investors’ heightened expectations. 

If anything, history tells us that when the pendulum swings too far in one segment of the market, a reversal of the trend can’t be far away.  Overlooked market sectors will undoubtedly get their just due before this recovery is over and it will likely come at the expense of the big dividend-payers.