One factor which could mitigate a dividend bubble ...

2011-08-18T19:38:07.732-07:00

One factor which could mitigate a dividend bubble is that any positive cash flow corporation has the option to become a dividend yielding stock. So if the demand for dividend stock became extraordinarily high, then new supply would rush in. However, low yields on bonds make it cheaper for a company to raise capital through borrowing than through enticing equity investors with big dividends.

I believe that bonds are at a greater risk of a bubble. I suspect that too much capital has migrated from equities to bonds. This has at least two consequences: bonds are priced too high (bubble potential) and too little equity puts companies at greater risk of default (bubble induced added risk). The burst of this bubble will happen when there is a surge of defaults (bubble trigger).

This is exactly what happened with real estate. Too much capital entered the housing market. Prices went up (bubble potential). Under conditions of rapid price appreciation, banks became increasingly willing to lend to marginal home buyers at very high loan-to-value ratio. These latecomers had little or even negative equity at origination before the bubble burst. It made sense to do so because a year or more at 20% appreciation meant that a comfortable 80% LTV would quickly follow. Mortgage defaults are exceedingly rare when there is a modest amount of positive equity because distressed borrows have the option to sell the property with dignity intact and a little bit of cash. But with thin equity, there is no second way out and the risk of default blows up. So thin equity induced added default risk which were not being properly worked into the price. Now the bubble is fully inflated and set at risk. A small hiccup in employment triggered a uptick defaults. Not enough buyers are to be found, and prices collapse 30 to 50% within the span of twelve months. Mounting negative equity triggers a flood of defaults. Still even two years latter more than 1 out of 10 mortgages are in default.

Bond investors need to be very wary of creeping default risk. To protect bondholders capital needs to flow back into equities. Dividend investors stand between the risks of price volatility and bond default risk. They are an important buffer between these risks. If a dividend yielding company becomes financially distressed, it has the option of cutting dividends, giving it a way to avoid default while it works out its cash flow problems. The same company without dividend investors will have little choice but to default. Now the options for recovery become quite limited, as the company gets reorganized in a way that is not favorable to stockholders. Hence, both bondholders and stockholders are placed at greater risk for lack of dividend investors who help absorb economic shocks.

Jdiggity,

This is a very hypothetical artic...

2008-06-14T17:31:00.000-07:00

Jdiggity,

This is a very hypothetical article so my answers would be hypothethical as well. This relates to the Dividend Aristocrats and Dividend Achievers, not to all dividend stocks.
Either interest rates will rise substantially and thus investors who have bought the abovementioned stocks on margin would want to sell at the same time or a major change ( tax change) might make it prohibitely expensive to pay dividends or maybe a recession could make most of the dividend growers to cut or stop increasing temporarily their payments.

If dividend stocks are the next bubble, what facto...

2008-06-11T15:29:00.000-07:00

If dividend stocks are the next bubble, what factors would cause it to burst, especially since these are "hold-forever" investments?

Comments on Dividend Growth Investor: The next bubble in the making.

One factor which could mitigate a dividend bubble ...

Jdiggity,This is a very hypothetical artic...

If dividend stocks are the next bubble, what facto...

Jdiggity,

This is a very hypothetical artic...