Home Stocks Crack A Beer, Stocks Still Look Kind Of Cheap

Crack A Beer, Stocks Still Look Kind Of Cheap

7 min read

Bottles of Coors beer are displayed on a shelf at a liquor store on May 2, 2018 in Fairfax, California. (Photo by Justin Sullivan/Getty Images)

There certainly is a correlation between interest rate moves and future stock price appreciation, with decreasing rates generally providing a lift for equities, all things equal. This is true for a couple of reasons.

First of all, lower borrowing costs have a beneficial effect on the price of most assets, like real estate, stocks, and private companies, because prices are the sum of future cash flows discounted by the risk-free (long-term U.S. government bond) rate. The lower the discount rate, the higher the asset price.

Secondly, bonds compete with stocks for investment dollars, and when bond yields fall, they provide a much lower hurdle for stocks to clear. This is the foundation of the “Fed’s Stock Valuation Model” developed two decades ago by Edward Yardeni who posited a relationship between the forward earnings yield of stocks and the 10-year Treasury bond yield. The earnings yield is the inverse of the price-earnings ratio, so if the market traded at 20 times earnings, the earnings yield would be 1/20, or 5%. The size of the spread between the earnings yield and the bond yield dictates whether stocks are cheap or expensive relative to bonds.

The earnings yield of the S&P 500 Index currently stands at 4.37%, and the yield on the 10-year Treasury note is at 2.89%, for a difference of 1.48%. Although narrower than it was five years ago, the differential still favors stocks.

10-Year U.S. Treasury Yield vs. S&P 500 Index Earnings Yieldycharts

The Fed Model has its shortcomings, including a lack of efficacy during periods of high-inflation, as well as the imperfect record of the earnings yield to represent the expected return on stocks.

Another perhaps simpler model which suggests a favorable year ahead for stocks is one that compares the dividend yield on the S&P 500 Index with the yield on the 10-year U.S. Treasury note. In 2012, S&P Capital IQ showed the year-ahead return for the large-cap index for various differentials between the dividend yield and the Treasury yield. Essentially, the greater the difference between the two in favor of the dividend yield, the higher the year-ahead gains for the market.

Source: S&P Capital IQS&P Capital IQ

With the dividend yield on the S&P 500 index now at 1.79% and the 10-year Treasury yielding 2.89%, we are in the range between -1 and -2 percentage points, which corresponds with an average one-year return of 5% for the S&P 500.

Roll Out The Barrel

My preference when it comes to equity investing, as articulated in the Forbes Dividend Investor newsletter, is to seek out value-priced stocks with high and rising dividend payouts. Here is one recent addition.

Denver, Colo.-based Molson Coors Brewing (TAP) was formed in the 2005 merger of Coors Brewing Co. and Canada’s Molson. It also owns the Miller Brewing company through its wholly-owned MillerCoors subsidiary, the second-largest seller of beer in North America, trailing only Anheuser-Busch Inbev (BUD). The International division operates in Latin America, Europe, Asia and Africa. Analysts expect 2018 revenue of $10.97 billion, down 0.3% from 2017. Molson Coors has grown EBITDA 26.8% annually over the past five years, while the company trades at discounts to five-year average valuations on nearly every metric you can measure.

Molson Coors and its predecessor organizations have been paying dividends for more than 30 years, and the ex-dividend date for the next $0.41 per share payout is August 30. Annual dividends of $1.64 are not a stretch for the company which produced free cash flow per share of $8.07 over the past 12 months.

John Dobosz is the editor of Forbes Dividend Investor and Forbes Premium Income Report.

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