Dangerous Dividends

It's been a messy year for markets, but have you seen the returns of high-dividend utility stocks?

Consolidated Edison (NYS: ED) is up 25% over the last year, and by more than half over the last two years. Shares have been on such a tear lately that the stock's dividend yield has dropped to the lowest level in more than 14 years. Another utility, Southern (NYS: SO) , has risen so far so fast that its dividend yield is now near the lowest on record.

Verizon (NYS: VZ) shares are also up nearly a third over the last year, and have surged 80% in the last two. Cigarette giant Altria (NYS: MO) is up 28% in the last year, and has been on a nearly uninterrupted 170% boom since 2009. Its sister company Philip Morris International (NYS: PM) has done even better, doubling in the last two years. Its dividend yield has plunged to just 3.5% -- lower than I think anyone owning a tobacco company ever expected to see.

Frankly, it's getting dangerous.

A few months ago I used the phrase "dividend bubble" to describe the herd of investors chasing yield without much regard for value. "Blue-chip dividend stocks are not subprime bonds," I wrote. "But there's an argument to make that, just as investors ran blindly into subprime bonds five years ago in search of yield, they're running blindly, carelessly into dividend stocks today." Since then, most of these stocks have only gotten pricier.

What now?

One thing we know is that the future returns of these stocks are lower today than they were a year ago. That's just the mathematical certainty of stocks that grow faster than their earnings. But that doesn't necessarily mean shares are about to sink -- yet. Dividend stocks have likely been on a tear because interest rates on bonds and cash are pegged near zero percent, and blue chip stocks offer some of the last respectable yields in town. As long as that's the case and interest rates stay low, there's a good chance dividend stock prices as a whole will stay high.

But what happens when interest rates turn? Someday, they will. And if the current bull market in dividend stocks is being goosed by low interest rates, I don't want to be around these companies when that happens.

Now, no one knows what that will happen -- interest rates could spike tomorrow or a decade from now. People have been warning for 20 years that Japan's interest rates will rise any day now. But is the possibility of a rise in interest rates even being considered by those piling into dividend stocks? I'm not so sure, and it could be a rude awakening to those who think they're buying low-risk investments. It's an added danger that can't be ignored.

On the other hand, several commenters pointed out that, as long as you reinvest dividend payments, lower share prices are actually a boon to long-term returns. This is entirely true. But how many investors can actually hold that mentality as they see their portfolios fall? History tells us, not many. Nearly every investor claims a desire to keep a cool head and be greedy when others are fearful, but most get a reality check about how difficult that is in practice when a bear market rolls around. Have an honest conversation with yourself. Would you actually be excited to see these stocks take a big hit? Maybe you would. If not, be aware of the risk you're taking and the hype fueling these companies' returns. Always remember that there's another side of being greedy when others are fearful: being fearful when others are greedy.

I personally own all the stocks mentioned in this article, and will likely be trimming my positions once the Fool's trading policy allows me. The risk-reward trade-off just isn't that attractive anymore. For other dividend stocks our analysts still like, check out The Motley Fool's free report: "Secure Your Future With 9 Rock-Solid Dividend Stocks." It's free. Just click here.

At the time this article was published Fool contributorMorgan Houselowns shares of Edison, Southern, Verizon, Altria, and Philip Morris International. Follow him on Twitter @TMFHousel.Motley Fool newsletter serviceshave recommended buying shares of Southern. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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