Investors looking for more income are pouring money into these pricey equities that are hitting our "stocks to watch" list now...
You see, both institutional and individual investors have moved out of the risk curve over the past few years to find the strongest income sources. They've explored everything from low-risk bonds to bank savings instruments.
Individual investors in particular have found it challenging to navigate the unfamiliar waters of dividend stocks.
They have rushed to invest their hard-earned dollars into familiar names that paid decent dividends, including electric utility stocks, telecom stocks, pharmaceutical companies, and large oil companies.
These well-known stocks have attracted attention from new investors, who looked for high-dividend payers with share-price gains since 2009 - when the bull market began.
Of course, anytime there is a buying rush in a certain class of securities, prices are pushed higher. And lately, excessive buying pushes prices further than usual, with extra market-moving juice from the U.S. Federal Reserve (which can't last forever, as this chart explains...)
That's why large blue-chip dividend payers are crucial stocks to watch now because they are showing signs of this type of pricing.
Why These Are Stocks to Watch for Overpricing
Yield chasing after an extended upswing is dangerous and could lead to losses far in excess of the income their shares provide.
A good example of a popular sector for blue-chip income investors that has gotten pricey is telecommunications.
At first glance, large companies like these seem to be solid investments as they pay decent dividends. But in fact, they are stocks to watch for overvalue.
A closer look shows that the telecommunications business is intensely competitive with very little overall revenue growth, as the growth in wireless and broad band is offset by the continued loss of wire line customers and weak business billings.
Here are two of the worst telecom dividend payers to buy now.
Dividend Stocks to Watch: AT&T Teeters Near Losses
AT&T Inc. (NYSE: T) looks particularly attractive, with a yield of a little more than 5%. However, when we look at the business conditions, we see that revenue growth is flat, and most of AT&T's earnings growth is the result of cost-cutting measures and stock buybacks.
The stock is currently trading at more than 20 times earnings and 12 times the analyst estimates for next year. The projected growth rate for the stock over the next few years is just about 6.5%, and the actual growth rate for the past five years is actually negative.
If you accept that the price/earnings (P/E) ratio should be just around the growth rate of the company - as many analysts do - then AT&T's stock is overvalued by about 33%.
It would only take a decline of $1.80 to wipe out the benefit of the dividend, so this is a stock to watch closely if it's in your portfolio. Most investors looking to put new money to work in the market might want to think twice about AT&T until its price falls to retrace some of its 70%-plus gains the past few years.
Stocks to Watch: Verizon Makes a Risky Dividend Play
Verizon Communications Inc. (NYSE: VZ) is in moderately better shape than AT&T, with gains in FIOS offerings and wireless data services producing some measure of revenue growth for the company.
However, revenue will still be in the single digits for the next several years, and the stock is richly priced when compared to its growth potential. Earnings have declined over the past five years and are expected to be about 10% going forward, but the shares are still priced at 14 times the average analyst estimate for the next year.
Thanks to yield-chasing investors (VZ yields 4.5%), the price of the stock over the past five years has more than doubled, even as business conditions worsened and sales and profits declined.
A drop of just $2.06 a share would eliminate the dividend payout for the year and leave investors with a loss on the supposed safe income investment.
What to Do Now
Luckily, there are sources of yield that aren't overpriced. These investments offer steady income sources that haven't had price inflation from investors pouring money into them.
We asked our Global Income & Investing Strategist Robert Hsu to explain what investors should look for when hunting for yield.
He told us what to watch in these stocks and shared one of his favorite picks for income.
Go here to get the scoop: 5 Dividend Stocks to Buy Now