Greg Powell: Hi, I’m Greg Powell, Chief Investment Officer at Miller/Howard Investments.
Like the broader market, returns for high-yield dividend stocks come from earnings growth, changes in price-to-earnings multiples and, naturally, dividends.
The real difference between high-yield dividend stocks and the broader market is the mix of sources of return. This chart shows the annualized decomposition of return for the S&P 500 Index compared to the high-yield dividend stocks within the S&P for the years 1993-2020. As you can see, high-dividend stocks performed slightly better over this period, with significantly more return coming from dividends.
It’s important to note that earnings growth was less for high-yield dividend stocks as a group. At Miller/Howard, we are acutely aware of this trend and that is why we focus our research process on finding dividend stocks with good earnings growth potential.
What might be surprising is that multiple expansion benefitted high-yield stocks more than the broad market.
We view the trend towards higher P/Es for the broad market to be a direct result of the long-term downward trend in interest rates. Investors have been using ever lower discount rates to evaluate earnings far into the future, driving up P/E multiples, particularly on mega-cap growth stocks.
Within the high-yield dividend stocks, the link between interest rates and P/E multiples primarily comes from the bond proxies. These are stocks with little earnings growth but steady dividends. As bond prices have inflated over time, it follows that the price of bond proxies would keep pace.
This chart shows the P/E of the two sectors with the most bond proxies, utilities and consumer staples. As you can see, the P/E for high-yield dividend stocks has moved up with the P/E of the bond proxy sectors.
We view it as unlikely that market P/E multiples will continue to expand over the long-term. This is based on two observations:
- P/Es are well above their long-term average, and second...
- Interest rates are low and more likely to rise than fall from the current level.
At Miller/Howard, we think the best defense against multiple contraction is to stick with stocks that have relatively low P/E multiples. We are finding many stocks at reasonable valuations that offer potential returns primarily from dividends and earnings growth.
Thank you for listening today, and for more information, please visit us at www.mhinvest.com.