Prior to fifty years ago, dividend yields were always higher than bond yields. It made sense, at the time, that stocks were risky and therefore needed to offer higher current income to entice investors to buy.
Bond yields have been low recently, in what Alan Greenspan called a “conundrum.” It’s clearly visible in the chart above that stock yields, during the depths of the market crash, approached parity with bond yields. Recognizing that stocks offer the potential for capital growth as well as current yield, this situation appeared to be a bargain.
One aspect that is ignored when comparing dividend yields with bond yields is the proportion of free cash flow that is paid as a dividend (versus retained earning), known as the payout ratio.
Equities offer higher free cash flow than can be earned by owning a corporate bond. The proportion that is paid as a dividend becomes current income and the retained earnings, if invested wisely, should translate to future capital growth.
Viewed in this sense, bonds currently appear expensive while stocks appear to present bargains based on present profitability.