Companies with high dividend yielding stocks and payout ratios are trading at their historically highest premium, leaving very little margin for error, writes Vadim Zlotnikov, chief market strategist at AllianceBernstein, who says that an emphasis on free cash flow yield, with an eye on rising payouts, provides a superior risk/reward profile.
Given the uncertain growth environment, return of corporate cash is valued far more than generation of cash, Zlotnikov says. While he finds high yield/high payout stocks to be a very crowded trade, he says the same cannot be said about dividend growth, as companies delivering strong dividend and payout increases through 2011 appear to trade at the same multiple as those not raising the payouts.
Zlotnikov says that a simple focus on highest dividend yield and payout would have served investors well in 2011, but that given the unprecedented valuation gap, a focus on the growth in dividends and payouts, rather than absolute yield and payout, offers a better risk/reward balance today. Zlotnikov writes:
Appeal of dividend strategies is self-evident given absence of consensus on future sources of growth, high corporate profitability, and negative real rates. However, the obvious bets on stable companies with high yield and payout ratios have played out and a more nuanced approach is warranted. In the US, focus on high cash flow yields with potential to increase payouts should yield strong performance. Those opportunities are highest in healthcare, financials, technology, and consumer discretionary sectors.
Zlotnikov adds that dividend yield opportunities may be better outside of the U.S. at this point:
For investors able to source opportunities on global basis, there are still areas with high current yield and relatively attractive valuations. These broadly include financials in most regions, capital equipment and healthcare in Japan, telecom/consumer services in Asia, and energy/utilities in Europe.