Last week, investment banking behemoth Goldman Sachs came out with what I consider two pretty bold claims.
First, the S&P 500 will be flat for the rest of the year. Considering it is already trading near Goldman’s 2016 target price — fair enough.
Second, and most far-fetched, is that the Federal Reserve will move forward with three interest-rate increases by the end of the year.
But what is most disconcerting about these claims is that Goldman recommends the same solution for both scenarios — own dividend stocks.
Statements like these that claim dividend-paying stocks are the cure to all your market ailments fuel the type of euphoric investment sentiment that ends a bull run … which is exactly what I think is happening here.
It’s very misleading for Goldman to say that owning rate-sensitive stocks will help you thrive in a market where the Fed is aggressive at raising rates. In fact, dividend-paying stocks will be impacted the most in an environment where the Fed moves forward with three rate hikes this year.
Now, I don’t believe that the Fed will make the mistake of raising rates three times this year — at best, we will see one rate hike. But, when an investment bank like Goldman is blind to this reality, it tells me the dividend trade — i.e., dumping non-yielding assets for yielding ones — is at its end, and it’s time for investors to look abroad for better yield opportunities.
Let’s start with what’s wrong with the U.S. dividend-paying market — it’s overpriced.
To figure out just how overpriced these stocks really are, I ran a scan of U.S. companies based on their yield. I chose yields between 4% and 20%, because once you get above 20%, a dividend cut or cancellation becomes more likely.
The results turned up nearly 1,000 companies for analysis.
Overall, the average price-to-earnings ratio (P/E) for these stocks comes in at 27. To give you some perspective, the average P/E ratio for the S&P 500 currently rests at 24 right now, meaning that dividend companies are overbought when compared to the rest of the U.S. market.
Yet another staggering statistic is that of the nearly 1,000 companies paying dividends between 4% and 20%, only 54% reported positive earnings results. In other words, 46% of the 1,000 dividend-paying companies I looked at are not even profitable at the moment. By comparison, 90% of S&P 500 companies are currently profitable.
Combining these two data points, we have U.S. dividend-paying stocks that are fundamentally deteriorating, while still fetching extremely high earnings multiples. These are supposed to be solid companies that return cash to shareholders while trading at discounted P/E ratios due to their focus on returning cash to shareholders instead of growing their bottom line.
Now that we know dividend-paying stocks are overpriced within our borders, let’s take a look overseas.
The Foreign Discount
When I ran the exact same screen on foreign companies, it returned an average P/E ratio of just 15. Better yet, of the nearly 5,000 stocks screened, only 12% of those were not profitable, versus 46% in the U.S.
With an average P/E ratio of 15, foreign stocks are trading at nearly half the valuation of U.S. dividend stocks. What makes this bizarre is that most of the globe offers larger economic growth rates, meaning investors will benefit from the continued devaluation of the greenback, which makes foreign dividends worth even more in U.S. dollars.
Finally, U.S. dividend stocks offered a higher average yield based on the screens above — 7.6% versus 6.6% for foreign stocks. Clearly, this higher average yield comes at a hefty valuation, but it still doesn’t tell us how many choices there are. As for foreign stocks with yields above 7.6%, the total comes out to 1,165 — more than the total amount of U.S. stocks my scan produced.
All it takes is a cursory search for strong, dividend-paying stocks in regions such as Europe, Asia and Australia, and you can easily find nearly double-digit yields with a P/E ratio under 15 — something that is extremely rare in the U.S.
Keep in mind that many U.S. brokerages now offer listings in many Asian and Hong Kong markets, so you won’t even have to open a foreign brokerage account to benefit from the better earnings multiples offered by foreign dividend-paying stocks.
Editor, Pure Income