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VOL. 36 | NO. 43 | Friday, October 26, 2012
Desperately seeking dividends
The 10-year Treasury bond, which historically yields 5 percent, yields 1.75 percent today. At these levels, the risk/reward features of low yielding bonds and higher yielding stocks favors stock dividends over bond interest payments. However, with dividend yields in hot pursuit, investors have driven valuations higher for U.S. dividend payers. In fact, high yielding U.S. stocks now carry higher valuations than the market on average, far above their normal 20 percent discount. This is the highest valuation premium they have commanded since the 1950s. This does not foretell an immediate valuation collapse, but it does beg the question, are there better alternatives?
Currently, the S&P 500 offers a 2 percent dividend yield. The ex-U.S. developed countries offer a 3.7 percent dividend yield. Surprisingly, the more swiftly growing emerging markets yield nearly 3 percent. At the country level in the developed world, the United Kingdom offers a 4.1 percent yield, France a 4.2 percent yield, and Australia a 4.9 percent yield. In the emerging world, China yields 3.3 percent, Russia 3.6 percent, and Brazil 4.1 percent. Outside the U.S., these dividend yields well exceed their 10-year averages unlike the U.S. yield, which mirrors its 10-year average.
By combining economic growth rates, valuations and current yields, we can now evaluate the regional alternatives. The U.S. has a 2 percent economic growth rate, a trailing five-year multiple of 20x earnings, and a 2 percent dividend yield. Europe has a 0 percent economic growth rate, a trailing five-year multiple of 12x earnings, and a 3.7 percent dividend yield. The emerging markets have a 5 percent economic growth rate, a trailing five-year multiple of 14x earnings and a dividend yield of 3 percent. Seen in this light, the “quality” premium for the U.S. seems a bit much. European payouts might seem vulnerable with the European economic condition, although they do begin far higher than their U.S. peers. The emerging markets, on the other hand, boasts higher growth, lower valuations, and higher payouts.
Those of you fearful about the term “emerging markets” might consider how mature they have become. While the emerging markets only account for 13 percent of world stock market capitalization, they comprise 50 percent of world GDP. Conversely, U.S. companies comprise 47 percent of world stock market capitalization, while the U.S. only contributes 19 percent of world GDP. Based upon these divergences the emerging markets are vastly underappreciated.
Another way to assess the maturity of these markets is to consider their sovereign bond yields. Obviously, bonds in risky regions like southern Europe trade at steep discounts and high yields. For orientation, the yield on the 10-year Greek bond is 18 percent, and 6 percent on the Spanish 10-year bond. Across the emerging markets, yields have fallen consistently since the early 2000s and now average 4.5 percent across the category. Lower debt burdens, higher growth rates and steadily improving credit ratings have curried favor with yield-seeking bond investors. This should ultimately encourage yield-seeking stock investors as well.
David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Waddell & Associates, with offices in Nashville and Memphis.