With stocks having staged a strong rally, and changes in political leadership stealing all the headlines, I thought it would be interesting to see an update of our Dow Jones Dividend Valuation Model. The model is a regression of dividend growth and changes in interest rates versus changes in the Dow's price over the last 45 years.
The model can best be understood by thinking of the green bars as valuation steps. The chart shows that as a result of very strong dividend growth and moderate changes in interest rate that stocks are more undervalued now than they were at the start of the year, even considering their solid price performance this year.
The model is being pushed higher by bond yields being lower than their long-term average and dividend growth being much higher than its long-term average. The Dividend Valuation Model is signaling that stocks are still nearly 10% undervalued, which would target a level above 13,000.
Another 10% move seems a bit ambitious, especially when considering the gains made so far this year and the uncertainties in the political arena.
The change in political leadership is not a great surprise to the market. The polls and various overseas betting lines showed such a possibility for months.
The momentum remains positive for stocks and, in my judgment, there is a clear valuation gap that is likely to close to some degree over the next year.
Thursday, November 09, 2006
Stocks Are Still Undervalued
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4 comments:
How does the present dividend payout ratio of the SPX compare to historical levels?
I was under the impression that despite the changes since 2003 giving dividends much more favorable tax treatment, the payout ratio was historically very low.
How do you get to under-priced fromt hat?
the yield on DIA is 1.98% on the SPY it is even lower at 1.67%
If you stick to the basic's, and not start inventing fancy math to prove your point, you will see that dividends are quite crappy at below 2%. Stocks are WAAAY over-valued. When was the last time you had over a 4% yield on the DOW?
The valuation of the dividend yield on any stock is a function of interest rates and the company's dividend growth. I will do a blog on the relationships in some detail later, but think of this. Procter and Gamble now yield close to 2%. It's dividend has grown at 10.5 over the last 20, 10, and 5 years. It's stock price has wobbled much more than its dividend during this time, but according to my models, PG's dividend can explain a very high percentage of the annual move of its stock. That same model says PG is about 15% undervalued. Is the model a sure thing? No, but I find that over a three year period of time times and prices converge.
Interesting post on stocks.
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