The Power of Dividends
by Charles B. Carlson, CFA
Dow Theory Forecasts

What a difference 30 months make.

In 1999, dividend-paying stocks lagged non-payers by nearly 90 percentage points, according to Standard & Poor's. Investors' interest in growth stocks, especially technology issues, drove the demand for non-dividend- paying companies at the expense of dividend payers.

However, since the tech sector began imploding in 2000, dividend payers have beaten the rest of the market by 44 percentage points.

And through the first half of this year, dividend-paying stocks, as a group, were one of the few places to hide from the carnage. According to S&P, stocks paying dividends in the S&P 500 declined only 9% through July 7 versus a 32% decline in non-dividend stocks.

Clearly, dividends are popular again with investors for many of the same reasons that they always have been important to portfolio returns:

• Bird in hand. Remember that a stock's total return is the sum of a stock's yield plus capital gains. Obviously, in a climate in which capital gains are difficult to achieve, dividend stocks offer something that non-payers don't - a tangible return (that is, of course, as long as the firm does not omit the dividend). True, dividend-paying stocks can decline with non-payers during rough market climates. However, the dividend yield often cushions the blow. ?
• The power of compounding. Over time, dividends can provide a huge boost to portfolio returns. For example, since 1926, dividends on the S&P 500 have provided roughly 40% of the index's 11% annual return.
• Growing payouts. Dividend increases can generate big returns for investors over a long period of time. For example, an investment in a single share of a $100 stock yielding 3% would generate $60 in dividend income over a span of 20 years, assuming no growth in the dividend or share price. So, after 20 years, your principal (which remains $100) and dividend income would total $160. Now consider a stock that yields just 2% but increases its dividend by 7% annually. Buying one share for $100 and holding it for 20 years turns into $182. That $182 includes your $100 principal and $82 in dividend income.
• Tangible evidence of "real" profits. One of the more interesting fallouts from the accounting scandals is the reappraisal of dividends as tangible evidence of "real" profits for a company. Thus, dividend payers are receiving a bit of a "credibility" premium from Wall Street when it comes to their financial reporting.

Because investors have become more enamored with dividends, don't be surprised if more companies boost their payouts in upcoming quarters. During the lousy market from 1973 to 1982, for example, the number of annual dividend hikes was some 40% higher than the yearly average between 1956 and 1999.

The securities markets are subject to the risks of fluctuating prices and the uncertainty of rates of return and yields inherent in investing and past performance is no guarantee of future results.

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