Is there a bubble in dividend growth shares?

6th August 2012

At first glance it seems that there is. Adam Parker of Morgan Stanley is quoted by Merryn Somerset Webb in MoneyWeek as saying that "Defensive stocks are trading near a decade-high relative to their more economically sensitive peers".

Problems with the ‘bubble' theory

Like most things, it pays to dig a bit deeper and understand what a bubble really is.  The idea of a bubble can be misleading as it suggests that there's a single, all-encompassing bubble.  In other words a bubble in defensive, dividend growth shares may lead some investors to think that all dividend growth shares are in a bubble.

But that's not how it works.

Markets are made up of lots of individual components like houses in the housing market and stocks in the stock market.  At any given time there will be some houses, or some stocks, which are overpriced and some which are underpriced.  A bubble simply means that there are more overpriced investments in a particular asset class or group than normal.

Even at the height of the stock market bubble in the late 90s it was still possible to find shares that weren't part of the bubble.

In fact, bubbles favour the astute stock picker because when the market is in a bubble, simply buying the market through an index tracker is more likely to lead to poor future returns.  Stock pickers on the other hand can continue to look for attractively valued investments no matter how overblown the market may be.

The same is true today for defensive, dividend growth companies. While there may be more overvalued defensive companies than usual, there are still plenty that are very attractive.

Avoiding shares with bubble valuations

Continue reading…

 

More on Mindful Money:

'The cult of equity is dying' – so is it time to buy?

The shocking truth about growth investors

Mindless With Money: How to be a mindful investor

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