ebook essays pieces of the puzzle
Tuesday, October 2nd, 2012
the new bonds

Given all of the attention that high-yielding stocks have received over the last couple of years, I thought I’d look for some where fundamentals had weakened over time.  Early in my screening, I noticed that the big drug stocks popped up.

Since I used them as examples in a presentation I used to give (years ago) about the characteristics of growth and value stocks, I thought I’d take a look at them.  Here are three:  Johnson & Johnson (JNJ), Merck (MRK), and Pfizer (PFE).

The top panel shows the total return for each since early 1991.  Nice overall, but it’s been a particularly rocky road for MRK and PFE since the late 1990s.  Even including their dividends, they are lower over that time.  JNJ is more diversified and has performed much better.

Over this period, the stocks went from growth to value.  The middle panel shows the dividend yields, which separated noticeably during the financial crisis but have now converged.

At the bottom you see the return on equity over time.  From thirty percent plus, they are now in the low teens.  So, it’s not “just a bond,” but with little growth on the top line and probably not much margin expansion available, they are close to it.

Which is fine with those that are buying these as fixed income replacements.  But “the new bonds” aren’t bonds, even though they are in demand as such from a good chunk of investors.  They probably will go down in price, just like bonds, if interest rates start rising, prompting a return of the discussion about the “duration” of common stocks, although from a different angle than we saw twenty years ago.  And, could other developments — regulatory issues, product problems, or tax changes — alter the attractiveness of these vehicles and send them lower?

Good things could happen too, but the “I’ll get some income and maybe some appreciation down the line” meme is fully discovered and perhaps overly exploited.  Without some new drug discoveries, the surprises would seem more likely to be negative ones than positive ones.  How will the buyers of these high-yield stocks react if they occur?  (Chart:  Bloomberg terminal.)