Income investors need to be careful with some of the best companies in America. A dividend bubble appears to be forming in many great stocks. Dividends have been one of the great drivers of investment decisions for the past two years, as it was the high-yielding utility sector that performed the best of the S&P 500 sectors in 2011. The good news is that many of these high-yield dividends are in companies that are very defensive and should hold up well if the market heads south. The bad news is that money managers and investors are starting to (or will have to very soon) notice that the valuations are getting stretched and that the dividend yields are getting too low in many key high-yield dividend stocks.
There are several driving forces behind this move. Treasuries and bonds are becoming solely for those who just cannot take the volatility of traditional investing. The 10-year Treasury yield is a dismal 1.5%, and even the 30-year is yielding only about 2.6%. Getting more than 1% interest on a bank CD is becoming a challenge. Europe is threatening to pull down the American growth story in an election year. And all of this is happening at a time when the dividend taxes are currently set to increase substantially if no changes are made to the tax code before the end of 2012.
24/7 Wall St. has selected five possible dividend bubbles that are inflating right now. We have used Thomson Reuters for forward earnings estimates and analyst price targets. For a true bubble to exist, the stock performance had to be strong, the dividend yield had to be lower than in the recent past, the current year P/E ratio had to be above normal or above the market, and the consensus price target from analysts had to be less than the current share price.