Danger in Dividend Stocks

Winning trades rarely stay winning indefinitely. So anyone heavily invested in stocks or bonds that throw off lots of cash—whether through interest income or dividends—should beware of the abundant signs of frothiness. Sectors with the highest dividends are trading at rich premiums to the broad market, relative to the historical norms, warns Vadim Zlotnikov, chief market strategist at AllianceBernstein.

He studied the price-to-book and enterprise value-to-Ebit (earnings before interest and taxes) ratios of industry sectors relative to the broad market over the past 30 years, and found that sectors paying the highest dividends are fetching some of the highest prices they've ever reached in this stretch. Utility stocks, which yield about 4%, are more expensive than they have been roughly 90% of the time. Likewise, telecoms, which yield about 4.5%, are costlier than they have been about 80% of the time. The consumer-staples sector, which yields north of 3%, is in nosebleed territory, too: Its valuation is higher than it has been in almost 90% of its history.

Source: Baron's

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