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Dividends to the Rescue By Stephen J. Butler

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Are you old enough to remember dividends? Those were annual payments to stockholders. They were lost or forgotten during the nineties when shouldered out of the way by a booming stock market. Stock prices, relative to earnings, were so high that dividends, if paid at all, were only amounting to about 1% of the stock price.

Historically, dividends have played a large role in the recovery of seemingly doomed portfolios. After '73-74, it took the S&P 500 seven-and-a-half years to return to its pre-crash value from just a capital appreciation standpoint. However, when adding in reinvested dividends, the time period was only three-and-a-half years. One current popular newsletter keeps harping on the fact that the market required seventeen years to recover from its 1930's decline. This statistic totally ignores dividends which averaged as much as 10% per year during some years through the thirties up until the mid fifties.

Now, with large dividend-paying companies having lost over 30% of their value in the last two years, dividends offer some immediate gratification that can dramatically accelerate the recovery of a retirement portfolio. In a tax-deferred retirement plan, dividends accumulate without being taxed, so they are much more valuable as a wealth-generating tool than they would have been in a taxable environment.

Dividends are paid out as a portion of company earnings, so companies have to be profitable to support continuing dividend payments. As a general rule, the dividend amount per share remains constant in dollars and becomes a different percentage as the share price changes. It is a major event when a company changes its dividend payout per share. In some cases, companies will temporarily dip into capital and pay more in dividends than they had in earnings to avoid adverse publicity.

As a matter of principle, many companies simply don't pay dividends. They operate on the theory that profits should be spent to "grow the company" and generate returns to stockholders in the form of appreciated stock values. This philosophy can be valuable to us as we invest after-tax money, because our annual "earnings" of appreciation accumulate as tax-deferred, long-term gains. Today, however, the vast majority of us own the bulk of our stock market investments in retirement plans where this advantage goes to waste.

Where do we find high dividend yields? Utility funds, Real Estate Investment Trusts (REIT's,) the Dogs of the Dow, and screening for individual stocks that pay high dividends are all places to start.

Utility funds investing in companies providing power and phones have traditionally paid relatively high dividends. As a group, they currently pay dividends averaging about 3%. However, they have had substantial capital losses over the past two years thanks to the implosion of their telecommunications holdings. Today, however, with those 40% cumulative losses behind them, these funds offer a steady stream of dividends and an improved possibility of future gains. Vanguard's Utility Income Fund is shifting gears and changing its name to Vanguard Dividend Growth Fund in an effort to focus on the entire spectrum of dividend-paying companies and industries.

REIT funds invest in real estate properties and have been paying dividends averaging 7% for the fund sector as a whole. In addition, these funds have generated substantial capital gains over the past three years where they had previously been flat for some periods. My only hesitation with this category is that they could become victims of their recent success. With new buildings still coming out of the ground across the country and with an economy that is languishing, I would be concerned about a reduction in dividends and a drop in capital values if the past two years have represented what looks like a "bubble."

The Dogs of the Dow are the ten stocks of the Dow Jones Average that pay the highest percentage dividend. Right now, that list includes various household names paying an average dividend of about 4%.

Finally, a little research using one of the free screening tools on the Internet can generate long lists of individual stocks that pay dividends of well over 10% per year. Some company involving golf properties is paying 48%. Since there is no free lunch, we can all guess at the level of risk when companies offer two-digit dividend yields, but these screening tools are instructive and can be found at sites like www.multexinvestor.com and www.moneycentral.msn.com.

Dividends, then, are important to appreciate. If stock market capital values only increase over the next ten years by an average of 7% per year, then dividends will offer a substantial boost to annual returns. What's more, they will offer at least a smidgen of satisfaction while we endure what promises to be a choppy market in the years ahead. And finally, the growing attraction of anything increases its demand and value. Stocks or mutual funds that offer dividends may become increasingly popular with further publicity. A self-fulfilling prophecy should boost the overall values of dividend-producing assets, so if the concept is of interest, the time to explore the possibilities is now.

BUYandHOLD does not recommend any securities. Any securities mentioned above are being used for illustrative and informational purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy.