In recent weeks, the turbulence of the stock market has been palpable, with the long-sustained highs finally giving way to a notable declineA significant factor in this shift has been the performance of dividend stocks, particularly those linked to the coal sectorJust a few weeks ago, we observed a precarious rally from Chinese Shenhua and Shaanxi Coal, with both companies slightly retreating after reaching notable price pointsThe conversation around the sustainability and risks associated with dividend stocks, particularly coal stocks, has become increasingly pertinent to investors navigating these choppy waters.

The question at hand is: what drives coal stocks? At first glance, one might assume that the government's intervention to stabilize the market—often referred to as "Zhongte valuation support"—plays a crucial role in the performance of these stocksWhile this influence cannot be ignored, the intrinsic logic governing coal stocks is unique to the industry

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The ongoing supply-side reforms and the ambitious carbon neutrality goals have resulted in the phasing out of outdated production capacitiesStrict scrutiny over new coal capacity additions has only further contributed to a sustained supply-demand gap within the industryCurrently, the construction projects by publicly listed coal enterprises amount to just over 120 billion yuan, a stark contrast to the peak levels experienced in 2014, mirroring the struggles faced by the real estate sector.

Moreover, the dividends associated with coal companies stem from a pressing needThese enterprises are often backed by larger conglomerates, which possess a variety of assets and interest-bearing debts that require resolutionTherefore, the imperative for profits to be turned into dividends for shareholders becomes particularly acuteCompanies like China Shenhua and Shaanxi Coal, with substantial stakes controlled by their major shareholders, are practically guaranteed to maintain robust dividend payouts

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This creates a relatively reliable expectation of returns for investors, underpinned by industry-wide profitability.

To comprehend the dynamics of dividend stability, one must also consider how steady profits directly correlate with reliable distributions to shareholdersThe cyclical nature of the coal sector has managed to soften, lending credence to the narrative that characterized many dividend stocks before their surgesThe appeal of coal stocks, within this framework, can be likened to that of bonds: prior to the carbon peak targeted for 2035, stakeholders might perceive coal stocks as a kind of debt security, akin to water or highway-related assets.

However, a thought-provoking consideration arises: is there a bubble forming in the coal sector? Since 2017, shares in Shaanxi Coal and China Shenhua have skyrocketed by roughly tenfold, provoking comparisons with the spectacular gains witnessed in the healthcare, liquor, and renewable energy markets over the preceding years

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If a stock appreciates ten times in mere months without any skepticism regarding a bubble, it certainly raises eyebrows—especially given that 2023 has become indicative of declining revenue and profits across the industryThose who argue that current price-to-earnings ratios are manageable might counter that growth has stagnated.

Yet, the uniqueness of debt-like stocks lies in the timing of capital investmentInstitutional investors typically gravitate toward these assets when the risk-free interest rates are low, thereby creating a compelling spread between stock dividends and bond yieldsCurrently, the returns on fixed-term deposits from major banks hover around 2%, while ten-year government bonds fluctuate between 2-3%, significantly below the yields offered by several high-dividend stocksAs economic activity wanes and interest rates decline, the attractiveness of high-dividend assets becomes pronounced—especially when their yields eclipse the interest on risk-free options.

Presently, the average dividend yield of the CSI Dividend Index hovers around 4%, while the yields offered by major banks reach 5%, with coal stocks outperforming at over 6%. Although the rapid appreciation of dividend stocks has diminished their initial high yields, they remain within the realm of sensible investment options

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Once one comprehends the foundational principles anchoring these stocks, the notion of a blatant bubble in coal equities dissipates.

Nevertheless, the absence of an apparent bubble does not inherently translate to a lack of riskThe past three years have seen stocks like Shaanxi Coal experience drawdowns exceeding 30%, while China Shenhua maintained flat prices for 15 months post-March 2022. Such movements pose significant challenges for latecomers and trend-following investors who find themselves entering positions at market peaksThis brings us back to the initial caution surrounding dividend stocks: they are undoubtedly appealing for long-term growth, but the implementation of strategies to minimize entry points during market highs remains essential.

The deliberation surrounding institutional holdings presents yet another layer of complexitySome argue that the low levels of institutional ownership in coal assets suggest prevalent bullish sentiment

Yet, historically, such alignment often culminates at market peaks when enthusiasm reaches dizzying heights—characterized by spikes in fund subscriptionsThe current low institutional positions simply indicate that the promotional fervor surrounding dividend stocks has yet to reach its apex, thereby leaving room for future increasesHowever, the potential for day-to-day fluctuations remainsIf retail investors flock to these stocks en masse, it could prompt rapid price corrections, contradicting the supposed safety of their holdings.

What remains crucial is this: As long as the yield spread between risk-free assets and high-dividend stocks remains substantial, the coal sector, along with the larger dividend stock grouping, will likely maintain a protective barrier against acute risksHowever, there lies a delicate balance—while the long-term trends endorse a bullish perspective, short-term volatility is an undeniable reality