The market appears fixated on the Federal Reserve meeting that begins Wednesday, and the main question is whether the Fed will raise its federal funds rate target for the first time in nearly a decade.
An increased short-term rate is expected to send interest rates higher across the spectrum. That, in turn, could lessen the attractiveness of high-dividend stocks. After all, when higher yields are easier to find—in ultra-safe government notes or in risky junk bonds—holding stocks for their dividends becomes a less attractive prospect.
Within that group of high-dividend stocks, the ones that could potentially get hit the most are the richly valued ones, as there’s a greater chance that they have been overbought due to their yields. More generally, stocks with high valuations are seen as having less “cushion” to the downside should macroeconomic factors turn against them, since expectations that prospects will improve seem to be embedded into the shares.
The most common measure of valuation is the forward price-to-earnings multiple, which compares a stock’s price to the earnings analysts expect over the next year. And within the S&P 500, eight stocks have dividend yields of more than 5 percent, forward price-to-earnings valuations above 30, and are not the subject of rampant acquisition speculation (as is Williams Companies, which would otherwise qualify).
It’s worth noting that some of these stocks, like telecom company Frontier Communications and oil and gas driller Helmerich & Payne, have sky-high valuations because earnings expectations are nearly nil; the story for oil exploration and production company ConocoPhillips is similar.
Meanwhile, analysts expected energy transportation company Kinder Morgan to turn a mild profit in the next year, but the stock appears no bargain based on the numbers.
Of course, if crude oil prices bounce meaningfully, these energy stocks will see earnings expectations ratcheted up, making their valuations much more reasonable. But that has thus far proven a prodigious “if.”
Meanwhile, price-to-earnings is not considered the optimal valuation metric for REITs like Ventas and Health Care REIT, but it is a method that permits comparisons to other types of stocks. And indeed, bond-like REITs are classically considered to be among the most vulnerable to rate rises.
Investor sentiment has become quite fearful around some of these names, according to Stacey Gilbert, Susquehanna’s head of derivative strategy.
“Positioning overall is much more cautious in Frontier than we have seen in some of its competitor stocks,” Gilbert said in a CNBC “Trading Nation” segment Monday. And when it comes to Marathon Oil, the options market is pricing in a 20 percent dividend cut, according to Gilbert.