Dillian: Bubble In Dividend ETFs Looms

November 13, 2013

Investors plow into dividend stocks and ETFs, to their peril.

Jared Dillian is the editor and publisher of The Daily Dirtnap, a market newsletter for investment professionals, and the author of “Street Freak: Money and Madness at Lehman Brothers.”

“Super Size Me,” the movie by Morgan Spurlock about McDonald’s and its unhealthy hamburgers, is one of my favorites, even though I really loathe the busybody documentary genre. I still laugh at the scene where Spurlock tries to eat an impossibly huge super-sized McDonald’s meal in his car and ends up vomiting out the window.

Beyond being laugh-out-loud funny, the movie is remarkable in how accurate its predictions about obesity were. The movie actually underpredicted how overweight people were going to get, and without realizing it, was way out in front of the idea that fast-food companies could offer food with very-high caloric and fat content very cheaply. Watching it almost 10 years hence, it was really ahead of its time.

So if you, as an investor, had seen this movie in 2004, you might have been compelled to sell short shares of McDonald’s in anticipation of a wave of lawsuits and regulation. Certainly, there have been lawsuits, and public perception of fast-food operators has been declining for years, but that would have been a terrible trade. The stock is up more than 300 percent since then.

And then you have Coca-Cola , whose product, when consumed in excess, is known to cause diabetes, a huge public health problem—and the stock just relentlessly puts in new highs. Here is a company with almost zero prospect for growth, already operating in nearly every country in the world, whose product is facing an imminent threat of regulation, and yet the stock trades at 19 times earnings. I wouldn’t want to pay 19 times for a no-growth company with a flawed business model, but people are doing it.

And finally, you have the example of the tobacco companies, who, after being hit with a master settlement agreement in 1999, have been paying off hundreds of billions to state governments for more than a decade, in addition to being forced to submit to the strictest regulations possible. And the stocks are up about 10 times since then. Meanwhile, e-cigarettes pose an existential threat to their business model, and with the exception of Lorillard (LO), few of the tobacco companies really seem interested in addressing this challenge.

What is going on? Well, to a large extent, consumer staple stocks like McDonald’s, Coca-Cola and Philip Morris were sort of backlash against the worst excesses of the Internet bubble, where investors went to the other side of the style box and lived there for 10 years. Suddenly it became cool to have a real company with a real product and real earnings, and more importantly, a real dividend.

And those dividends became of crucial importance when short-term (and long-term) interest rates reached cycle lows. A 3-4 percent dividend on a consumer staples stock looks amazing when held up against 10-year Treasury notes yielding around 2 percent.

Plus, if you recall, lowering taxes on ordinary (qualified) dividends was a big part of President George W. Bush’s re-election strategy, and quite literally, the day after the 2004 election, investors plowed into high-dividend stocks and dividend ETFs, like the iShares Select Dividend (DVY | A-67). I was there, trading ETFs at Lehman Brothers at the time, so I remember it well.


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