Hold On to Those Dividend Payers

 | Aug 14, 2013 | 11:30 AM EDT
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For equities, price-to-earnings ratios tend to be the most common way to arrive at a valuation -- and, while the S&P 500 Index has averaged a P/E ratio of 15.5x, as of Tuesday's close it totaled 19.3x. Stocks, therefore, are well above their historic valuations. Equities are still cheap compared with bonds, but U.S. Treasury yields are going up, and at some point this P/E ratio will have to come back to normal.

We income investors tend to be in our investments for the long-term, so the question of when to sell can be the toughest one. When we specifically consider stocks that pay dividends, we must keep in mind that they tend to be less volatile than those that don't: Income will puts a floor under the price of these shares, meaning that if the market drops, these stocks will tend to drop less. By selling these names, in other words, we are also forgoing the income -- so it adds extra weight to holding.

In short, unless you are looking to make a quick trade, don't unload fundamentally good dividend names until it is an obvious time to sell and, indeed, too dangerous to hold.

For the most part, I don't believe the market has reached that point as of this moment. While most stocks should not be added at these higher valuations, the passive investor should not yet sell dividend stocks, either. In this article, I will key in on a few dividend names that I feel are analogous to the situation as a whole. All of these are dividend payers with some growth and good fundamentals.

During the most previous pullback of 5%, real estate investment trusts were among the hardest-hit, and many have not recovered all that much. Shares of Realty Income (O), a mega-diversified retail REIT, lost more than one-quarter of their value and have been waffling ever since. Yet, with a dividend yield of above 5.1%, now is no time to give up on this stock. That's even despite an 18.2x ratio for price to funds from operations (FFO is the preferred bottom-line metric for REITs).

AT&T (T) is sort of in the same boat. The biggest telecom provider in the U.S., this is a solid business, and it offers a nice yield of 5.2%. Its P/E ratio is down at 17.2x, slightly below the company's 15-year average. If a passive investor wants to put money to work in any investment, this might be the one to add right now. Waste Management (WM), on the other hand, is legitimately expensive. Its dividend yield has dipped to a multiyear low of just 3.4%, which is particularly scant, considering the company's utility-like nature. A P/E of 20.5x doesn't help, either.

Moving on to consumer staples, Procter & Gamble (PG) has now reached a P/E of 19.6x, which is also its average for the past 15 years. I admit it will be difficult to get much more out of this name. The yield is just under 3%. Kimberly-Clark (KMB) yields a healthier 3.3% and is at 17.7x earnings. While this is above the stock's 15-year average, Kimberly is doing better than P&G and has raised its dividend by 9.5% this year. There's no need to dispose of this cash machine.

When compared with dividend payers this year, pipeline names have been a disappointment. Despite continued distribution growth, Kinder Morgan Partners (KMP) has lagged with the rest of them. The stock yields more than 6.4%, so now is not a good time to sell. In fact, that yield – along with sustained 5% to 7% distribution growth -- is a good combination.

For now, it's best for passive investors to hold on to dividend-paying names. However, we should revisit this thesis if S&P 500 levels climb another 10 or even 5 percentage points. Stocks in general are not cheap right now, and even the passive investor must be vigilant.

Note: Historical P/E data comes from FAST Graphs.

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