Dividend investors at a crossroads

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

from the March 3, 2008 edition

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Although cash dividends are growing – by an expected average 9.3 percent among S&P companies this year – these percentage increases have been slowing, evidently as companies opt to pour money into stock buybacks.

Beyond market factors, experts cite rising concern about the prospect of higher taxes on dividends. Unless Congress intervenes, the current dividend tax rate is set to expire at the end of 2010 – an issue that's already being discussed in the current presidential campaign.

Without the favored tax rate, at least some observers believe that dividend-paying companies could lose part of their draw. Indeed, a 2007 survey by Eaton Vance of 375 financial advisers and 402 investors age 61 and older, showed somewhat differing outlooks from the two groups on the effects of a possible higher dividend tax rate. Among other findings, the survey found that "many" advisers believe that if the 15 percent maximum rate is repealed or expires "investors will increasingly favor other income-oriented vehicles over stocks. And 58 percent [of respondents] predict companies will deemphasize dividend payments in favor of capital expenditures and stock buybacks."

But data show seniors responding to the same survey were more sanguine: If the dividend tax cut is repealed, "more than half [of senior investors] say they will not adjust their portfolios, and only 18 percent say they will invest less in dividend-payers," says the survey report.

Moreover, this year's performances of the dividend-paying group have been encouraging. For instance, in January, the 387 dividend payers in the S&P 500 stock index posted an average 4.1 percent drop in total return – beating the 113 nondividend payers in the index by almost two percentage points.

For those shopping for such stocks, there's no shortage of companies to choose from. To help find and research them, Mr. Donaldson cites such websites as www.dividendachievers.com and www.dividendinvestor.com. In addition, Standard & Poor's provides information on S&P 500 dividends at www.marketattributes.standardandpoors.com.

Indeed, as one source of individual shares, the S&P 500 index "is loaded with dividend payers," says Howard Silverblatt, S&P's senior index analyst. Fully 77.6 percent of companies in the S&P 500 index pay cash dividends – versus 38.8 percent of non-S&P 500 companies, he reports.

In addition, Morningstar counts 23 exchange-traded funds and 54 mutual funds in its universe that have the word "dividend" spelled out in their name.

For his part, Donaldson likes companies "with a long history of raising their dividend every year." He cites five stellar examples: Colgate-Palmolive, Procter & Gamble, Coca-Cola, Vectren, and Progress Energy. These companies, Donaldson says, not only have raised their dividend annually for at least the past 20 years, but also have a stock whose price has bested the market over the past turbulent six months.

But for those investors seeking dividend-paying companies, there's also a widely agreed-upon cautionary rule of thumb: Don't pick companies with sky-high dividend yields, say in the 14 to 15 percent range. In that case, such yields can signal that a company is in financial trouble – and that its dividend-payout level may not be sustainable.

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