Dividend Yields Lagging Returns On Treasury Bills

With the U.S. economy expanding at its strongest pace in 10 years, the news on corporate dividends is bright and getting brighter.

But it hasn’t shone enough to inspire any lasting rally in the stock market - or to relieve worries on Wall Street that stocks are overvalued and vulnerable to a setback.

The number of companies that raised their dividends rose 12 percent in 1994 to its highest level in a decade, reports Standard & Poor’s Corp. Analysts at the firm look for a further gain of around 10 percent this year.

The number of companies that reported negative actions - cutting or eliminating their dividends - last year was the smallest since S&P began tallying the data in 1956.

Nevertheless, the rate of improvement in dividends hasn’t kept pace with recent earnings growth at many companies. And the dividend yield on the typical stock remains below 3 percent, a range analysts consider high-risk for the market.

With interest rates much higher than they were a year ago and apparently still rising, that is an especially sore point for stockmarket watchers.

“A year ago, the bulls’ justification for stocks yielding less than 3 percent was that Treasury bills paid barely more,” says Norman Fosback, editor of the Market Logic newsletter.

“Now Treasury bills earn 6 percent and stocks still yield less than 3 percent, suggesting that at least by this measure equities are more vulnerable now than a year ago.”

The situation isn’t as extreme as it looks, many observers point out, once you consider how many companies have opted in recent years to devote some of their cash to stock buybacks instead of cash payouts.

But if large further increases in payouts aren’t forthcoming, the bears point out that there is only one logical alternative. “Either dividends must increase or the market must decline,” says Rao Chalasani, investment strategist at Kemper Securities in Chicago.

“Investors’ willingness to bid up the price paid for $1 of dividends is usually constrained by the competitive rate of return on alternative investments, such as bonds and short-term securities, as well as future expectations for interest rates and dividend changes,” he said.