Dividend investors at a crossroads

Market swing, tax changes may give reason to pause, not panic.

By Margaret Price | Correspondent of The Christian Science Monitor

from the March 3, 2008 edition

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New York - When red ink splashes across your stock portfolio's statements, as it might be doing now, you could consider fleeing to stocks of companies that pay dividends. At least this way, you'd pocket some reward as stock prices swoon.

Or, maybe you shouldn't act too fast: Amid a changing market cycle and with possibly higher tax rates ahead, questions are arising about the allure of dividends.

Certainly, the long-term performance of dividend-paying stocks have been eye-catching: Over the 36 years ended Jan. 31, 2008, firms in the S&P 500 stock index that initiated or raised their dividend posted a 10.5 percent compound annual return. Over that same period, companies in an equal-weighted S&P 500 index had an 8.1 percent return and nondividend payers in this index produced a paltry 2 percent showing, according to Ned Davis Research.

"Stocks of dividend-paying companies … tend to be a port in the storm," says Ed Clissold, senior global analyst at Ned Davis Research in Venice, Fla. "When capital appreciation is weak or negative, investors still get the advantage of total return boosted by dividends."

And when investors take dividend payouts, they can get a useful income stream – money to pay bills or even to buy stock in another company.

As baby boomers age, many experts see more of them gravitating to dividend payers for retirement income. In order for retirees to make their assets last through their lifetimes, they "should only tap 4 to 5 percent of their investable assets per year" for living expenses, notes Greg Donaldson, whose firm, Donaldson Capital Management in Evansville, Ind., specializes in managing portfolios of stocks of dividend-paying firms. "If people invest in common stocks that yield 4 percent to 5 percent, they may never have to dig into their principal."

In this decade, investors found added reasons to embrace dividend-paying stocks. On the market front, the tech-stock meltdown early in the decade helped trigger a swing away from growth stocks to value issues – the category many dividend payers fall into.

Added to that trend was the favorable change in tax rates on stock dividends. In 2003, the federal individual income-tax rate on qualified dividends dropped to a maximum 15 percent. Experts say that change spurred more companies to raise or initiate dividend payments and heightened the appeal of dividend-paying shares.

Indeed, after that tax-rate cut, "the amount of income distribution passed on to investors increased significantly," reports Tom Roseen, senior research analyst at Lipper, a mutual fund tracking company.

But looking ahead, trends seem less promising for dividends and their payers. Financial planner Steven Kaye, president of the American Economic Planning Group in Watchung, N.J., points out that the market cycle has tilted in favor of growth stocks since last year. In his view, the current pro-growth trend could last "at least a couple of years."

Meanwhile, some large companies recently have made dividend cuts. One oft-cited example: Citigroup's January announcement of a 41 percent shearing of its quarterly common stock dividend to 32 cents per share. In all, this year through Feb. 19, seven S&P 500 companies – all in the financial sector – have announced a dividend cut or suspension, compared with 13 such moves by companies in the S&P 500 in all of 2007, according to data from Standard & Poor's.

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