The S&P 500’s highest yielding dividend stocks are selling at their biggest discount in nearly 40 years as bond yields across the globe are plunging. Despite mounting fears concerning global trade, weak economic data coming from economic powerhouses like China and Germany, and the brief inversion of the U.S. Treasury yield curve last week, Goldman Sachs recommends a basket of dividend stocks with high growth potential and which are trading at bargain prices.
The basket is comprised of stocks from a range of sectors, offering impressive expected dividend yields (DY) for the year and attractive forward-looking price-to-earnings ratios (P/E ratios), including, AT&T Inc. (T) with a 5.9% DY and 9x P/E ratio; Kohl’s Corp. (KSS), 6.1% and 9x; Archer-Daniels-Midland Co. (ADM), 4.8% and 11x; Citizens Financial Group Inc. (CFG), 4.3% and 8x; AbbVie Inc. (ABBV), 6.8% and 7x; and Seagate Technology PLC (STX), 5.7% and 10x.
What It Means for Investors
The median stock in Goldman’s Dividend Growth Basket beats the median stock in the S&P 500 on a number of key metrics: a 3.8% estimated DY for 2019 vs. 2.1% for the S&P 500; a dividend compound annual growth rate (CAGR) between 2018 and 2020 of 9% vs. the S&P’s 6%; and an estimated PE ratio for the next twelve months of 11x vs. 16x for the broad market index.
Compared to what markets are pricing in, Goldman’s estimates for dividend growth are definitely optimistic. Swap market prices suggest dividends are expected to grow at an annual rate of 0.7% over the next decade, while the investment bank’s analysts are calling for 3.5% annual growth over the same period. That difference in expectations combined with the historically low valuation discount for dividend stocks makes it easier to understand why Goldman’s analysts think there is a great bargain to be had.
Slightly less optimistic, asset management firm Janus Henderson recently reported that the pace of year-on-year dividend growth had slowed to 1.1%. But that’s for stocks across the entire globe, not just in the U.S., and even that tiny bit of growth helped push dividends to their highest level on record. Janus Henderson forecasts global dividend payouts to post a 4.2% rise by the end of the year, according to the Guardian.
Those big dividends are looking especially attractive in a world where U.S. 10-year Treasuries are yielding a little over 1.6% and bond yields around the world are plunging, many into negative territory. While investors have been accustomed to negative yields on sovereign bonds for several years now, they’re now starting to acquire a taste for negative-yielding corporate debt as well. The total amount of negative-yielding bonds across the world was up to nearly $17 trillion last week, according to Bloomberg.
The plunge in yields comes as investors rush into bonds and bond funds amid concerns over the health of the global economy. Expectations of deflationary pressures mean even nominally negative yielding debt could potentially earn a positive real interest rate, and expectations of yields continuing to fall as central banks implement easier monetary policy mean investors may be able to sell their current bond holdings at a higher price in the future and pocket the gains.
Indeed, expectations of future interest rate cuts by the Federal Reserve helped push the yield on 10-year Treasury notes below the yield on 2-year notes, an inversion of the yield curve not seen since before the financial crisis. The inversion of the 2s10s part of the yield curve has historically been a fairly reliable predictor of a coming recession.
Despite the ominous warning sign delivered by the yield-curve inversion, stock investors don’t need to get too worried, at least not yet. Goldman notes that the average time until recession following the last five inversions has been 22 months. Meanwhile, the S&P 500 has averaged a 12% gain over the first 12 months after an inversion occurs.