Why Stock Dividends are Sexy Right Now
Halina is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Stock dividends are getting sexier by the day and are no longer the domain of aging baby boomers and retirees. According to a report by Silverblatt, a grand total of 401 S&P 500 companies will be paying $279 billion in dividends in 2012. This beats the record set in 2008, when a total of 372 S&P 500 companies paid out $248 billion in dividends to their shareholders. Furthermore, many companies already paying dividends increased their payouts in 2012; Sturm Ruger (NYSE: RGR) just changed its quarterly dividend from 21.25 to 32.4 cents, an increase of over 52%, while ExxonMobil (NYSE: XOM) changed its quarterly dividend from 47 to 57 cents, an increase of 21%. Companies like Cracker Barrel (NASDAQ: CBRL), Coach and Chevron (NYSE: CVX) have followed suit, increasing their dividend payouts by 60%, 33% and 11%, respectively. Meanwhile, G&K Services (NASDAQ: GK) recently paid a special cash dividend of $6.00/share on top of declaring a 50% quarterly dividend increase. Why is there such a recent focus on dividends?
According to Joshua Peters, an equity analyst at Morningstar, "Chief executives and corporate boards are...noticing that investors are rewarding dividend-paying stocks." As a result, many companies are under pressure to either start paying dividends to shareholders or to increase the dividends that are already getting paid out. Stockholders, meanwhile, are focusing more on dividend-paying stocks because economic conditions (e.g., Great Recession) have made it difficult to rely on capital appreciation alone. Whereas even a decade ago one could rely on stock price growth to make one's portfolio holdings increase at an average rate of 11% a year, stock appreciation these days is not an absolute guarantee. For example, if one had invested in an S&P 500 Index fund at the close of 2007, today that fund would still be 4.4% below its 2007 valuation. If one had invested in an S&P Index fund when the S&P was at its all-time high on October 9, 2007, that fund would now be a whopping 10% below its original valuation.
As a result of this uncertainty, it is little wonder that stockholders are flocking to companies that can assure them of a monthly or quarterly sum of cash. This is especially true of baby-boomers and retirees that depend on dividends as another source of fixed income. However, here are six more good reasons why investors are favoring sexy dividend-paying stocks:
1. Lower taxation rate
The IRS taxes dividend earnings at the top rate of 15% as opposed to 39.6% for ordinary income. Furthermore, taxpayers who are in the 10% or 15% earnings brackets pay no tax on their dividends. Of course, such favorable taxation assumes that Congress will continue to extend the Bush tax cuts on qualified dividends.
2. Lower volatility
A stock's beta is the measure of its volatility relative to the market. For example, a stock with a beta of 1 is on par with the S&P 500 Index while a stock with a beta of 0.9 is 10% less volatile than the Index. In general, stocks that pay a dividend have a lower beta, or measure of volatility, than dividend non-payers. Even given the last 5 years, dividend-paying stocks have carried a beta of 0.98 compared with 1.50 for their non-paying brethren.
3. Lower stock price loss
Dividend-paying stocks typically lose less on their stock price than dividend non-payers during a market crisis. In 2002, for example, companies that did not pay a dividend lost an average of 30% on their stock price compared with 11% for companies that did pay a dividend. In some cases, dividend-paying stocks even appreciated during a market crisis, such as shares of Proctor & Gamble (with dividends) actually earning over 9% in 2002.
4. Higher profitability
In 2003, money managers Robert Arnott and Clifford Asness found that companies that paid higher dividends also had higher subsequent profit growths compared to companies that paid lower dividends. The reasons for this unexpected finding included a lower propensity for management to conduct wasteful acquisitions and/or award itself additional salary bonuses. Likewise, management often uses company profits to retire stock shares. While a good idea in theory, most often the share buyback occurs when the company's stock price is at its peak, thus diluting the advantage of this move for management as well as stockholders.
5. Opportunity for growth through reinvestment
According to Ned Davis Research, $100 invested in the S&P 500 Index in 1930 would have yielded $5,683 today given the Index's 5.2% annualized total return. With dividends reinvested, that same $100 would have yielded $142,045 today at an annualized S&P 500 Index return of 9.4%. Obviously, dividend reinvestment leads to a higher ROI.
6. Fewer fixed income sources
In the early 80's, Treasury bond yields soared to almost 16% on average, making this investment vehicle attractive to many investors. By 2010, however, most bonds were not even making 4% on average and barely keeping up with inflation. As a result, dividend-paying stocks became more attractive to a good majority of retirees and other investors relying on fixed income sources.
Conclusion
As investors rely less and less on the capital appreciation of their investment portfolios, stock dividends are definitely looking sexier. This trend is likely to continue as the economy flounders and high unemployment rates make investors skittish about going all out for growth stocks. Personally, I rely on dividend stocks to pay my mortgage and household bills. Even though I'm years away from retirement, it's nice to know that I can count on my portfolio to take care of some of my living expenses. That feeling of security is something I wouldn't have if I'd banked on stock appreciation only.
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