News about dividends in the past year has mostly been negative. The number of U.S. companies decreasing dividends in 2009 was the highest since 1955. According to Standard & Poor’s, 804 companies reduced their dividend payouts by over $58 billion.
For investors who rely on dividends for income, it is a challenging market considering that money market funds are paying essentially nothing and neither CD nor Treasury rates are currently attractive.
There are risks with equity income compared to fixed income. A 5% income stream from a bond is not the same as a 5% dividend yield on a stock when risks of underlying principal are considered.
But there are several reasons to believe that dividend income from stocks is still a very important part of building financial security. Consider these observations:
- Since 1972, the average dividend-paying stock in the S&P 500 index has produced an 8.5% average annual total return. Non-dividend-paying S&P 500 stocks returned 1.2%. Source: Ned Davis Research, Business Week
- Looking ahead to 2012, analyst estimates predict that there will be an 18% rise in dividends per share for S&P 500 companies. Source: State Street
- Companies are likely to raise dividends partly because: “Cash as a percentage of corporate balance sheets was 12.5% at the end of 2009, the highest percentage on record.” Source: Business Week
- The S&P 500 Index as a whole had a negative return for the 2000s. But dividend-paying stocks fared much better.
- In markets that trade sideways, bouncing along over several years without much change in the overall value of the market, dividend-paying stocks allow for real wealth creation without price appreciation. This is demonstrated in the following chart reflecting the period from the end of October 1972 through the end of October 1982. Over 10 years, the Dow went from 955 to just 991.
Source: Lipper, Hartford Mutual Funds
We take into account four key points when making decisions about the percentage of dividend-paying companies in our client’s portfolios:
- When considering income from stocks, it’s important to be mindful of dividend yields that are high for the wrong reason. In some cases, the dividend yield (as a percentage of the stock price) is high because the stock price has been beaten down for good reason. That being the case, we focus on companies that may not have the highest dividend yield but do have a demonstrated history of regularly increasing their dividend payments.
- Generally, dividend-paying companies have participated the least in the market recovery over the last year. By many estimates they also now represent the most undervalued portion of the U.S. stock market.
- A properly balanced investment strategy calls for exposure to growth oriented stocks that do not pay a dividend. But, particularly for investors who prefer less fluctuation in their investment returns, dividend-paying companies may create more peace of mind.
- Diversification can also be added to your investment strategy through international dividend-paying stocks which tend to pay slightly higher dividends than U.S. companies.
