05/11/19 COMMENTARY: DOES THE DIVIDEND YIELD EVEN MATTER?

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COMMENTARY: DOES THE DIVIDEND YIELD EVEN MATTER?

The stock market is up by more than 30% over the past year, and a growing number of economists fear that investors are in the grip of a speculative mania. And by one time-honored barometer--dividend yield--they're dead right. The rule of thumb goes like this: When the dividend yield--dividends per share divided by share price--of the Standard & Poor's 500-stock index falls below 3%, it's time to take your money and run. The S&P's dividend yield today? 1.4%.
Time to sell? Not necessarily. The dividend yield has hovered below the historical danger zone for the past six years. And, far from being the result of a mania, the stock market's gains in the 1990s have largely reflected strong profits and a low-inflation economic expansion.
TECH'S TURN. Times change, and the dividend yield is no longer a sound valuation guide. One reason for the shift is the changing composition of the S&P 500. Five years ago, oil producers, auto makers, and other dividend-paying heavyweights vastly outweighed the dividend-barren tech companies in the index. Today, high-tech goliaths like Microsoft Corp. and Intel Corp. play a much larger role. In 1992, the market capitalization of Exxon Corp. was $74 billion, vs. $24 billion for Microsoft. Last year, the market cap of Exxon was about $170 billion, but Microsoft's was nearly $200 billion.
Another factor is the near-absence of inflation. The return on any stock is made up of dividend payments and capital appreciation. When inflation is high and rising, investors want as much return as soon as possible, so they look to dividends, says Richard Bernstein, quantitative strategist for Merrill Lynch & Co. But shareholders will wait for prices to rise when a dollar holds its value, he adds.
The low dividend yield also reflects a change in how Corporate America now chooses to share good fortune with stockholders. Today, companies are more likely to use retained earnings for periodic stock buybacks, rather than to boost dividends. Buybacks can boost share prices and, more importantly, they appeal to shareholders who can take advantage of the low capital-gains rate.
This isn't the first time investors have had to reconsider how to use dividends as a valuation benchmark. Up until the 1950s, common-stock dividend yields were higher than government bond yields. The reason: Since stocks were much riskier than bonds, they had to pay a yield premium. But four decades ago, the interest rate on government bonds rose above the yield on common stocks. And it has stayed there ever since. What happened? The economy had become more stable, and owning stocks a lot less risky, says Peter L. Bernstein, a New York-based economic consultant to institutional investors.
The market is unlikely to continue on its meteoric course toward Dow 10,000. It may even correct somewhat, and investors may flee to Treasury bonds, whose yields are currently four percentage points above dividend yields. But in no way is the market as insanely overvalued as a cursory look at the dividend yield would suggest.
By Christopher Farrell

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