Dividend yields represent the current sweet spot in the financial markets, according to Scott Schermerhorn, chief investment officer at Granite Investment Advisors, which manages $500 million mostly in separate accounts.
He is so enamored with stock valuations in relation to the strength and direction of dividends that he believes portfolios should be tilted strongly in favor of stocks over bonds.
“The time is now to be at the upper end of the equity allocation and at the lower end of the bond allocation,” he said.
The unusual situation in which the dividend yield on the S&P 500 Index is higher at 2.2% than the 1.94% yield on the 10-year Treasury bond is not the only proof that dividends are the stronger income source these days, Mr. Schermerhorn said.
Even so, the yield scenario stand outs.
Since 1962, the S&P's dividend yield has averaged around 40% of the yield of the 10-year Treasury, but is now at 113%.
This is also only the second time since 1947 that the S&P's dividend yield has been greater than the 10-year Treasury yield.
But Mr. Schermerhorn also compares individual company dividend yields to the company's entire capital structure, and finds many times that debt at these levels just doesn't pay.
Johnson & Johnson Ticker:(JNJ), for example, has a 3.5% dividend yield, but the company's three- to five-year bonds are yielding just 40 basis points.
“Five years from now, there's a good chance that [JNJ's] stock price will be higher and they will have raised the dividend, but you're losing money on those bonds because inflation is above 40 basis points,” he said.
From Mr. Schermerhorn's perspective, it is just simple and straightforward math.
The Granite Value Fund Ticker:(GVFIX), launched earlier this month and managed by Mr. Schermerhorn in a manner similar to the firm's managed accounts, shows that the average dividend yields of the top 10 holdings is double that of the bond yields of those same companies.
“Right now, people are still afraid [of equities], but that's when investors find the biggest bargains,” he said.
As a bottom-up stock-picker for a portfolio of around 35 stocks, Mr. Schermerhorn is not only looking at dividends, but he is finding them difficult to avoid.
“Equities grow over time, bonds don't,” he said. “It's got to be a fear-based decision keeping people in bonds looking for income, because at these rates, they are just losing money in a measured way.”
Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives.
