Savvy investors back in hunt for dividends

Dividends are suddenly in favor once again – both with investors and Wall Street.

Nearly two decades have passed since these cash payments to investors, taken from a company's profits, were considered as key to a stock's value. Back then, many investors sought out stocks of certain companies, such as utilities or banks, just to gain the dividend.

But along came the 1990s when growth-oriented stocks became the rage and – poof! – dividends dwindled. Payouts became smaller and less common. What counted became "price appreciation," with stock gains in effect hidden within the share price. Many companies, in fact, used profits not for dividends but to buy back stock to help drive up share prices.

Part of the reason for this trend involved taxes. Dividends are taxed annually at regular income-tax rates, not lower capital-gains rates that investors pay only when they profit from selling shares. In addition, dividends are somewhat suspect since they are perceived as being taxed twice – once at the cooperate level where profits are taxed, and then again at the individual level.

But in today's bear market, dividends are back, or at least back more than they were a year or so ago. Prominent companies boosting or promising higher dividends include Clorox, Coca-Cola, ExxonMobil, Washington Mutual, and Johnson & Johnson, which pays out $2.32 a share annually. Utility, financial, and commercial real estate firms also offer substantial dividend payouts.

"More companies are paying dividends or are willing to boost their dividends than in recent years," says Joseph Lisanti, a senior editor at Standard & Poor's Corp. and coauthor of "Dividend-Rich Investors."

In August, Mr. Lisanti says, some 90 companies increased dividends, compared with 65 in August 2001. In July, 131 firms boosted dividends, up from 100 in July 2001. This represents the first back-to-back months of dividend increases since March and April of 1998.

The reasons dividends are popular again are obvious, he says. If an investor can receive a 3 or 4 percent return in the form of dividends, plus a 2 or 3 percent return on appreciation, their total return would be well ahead of most Treasury-bond, money-market, and CD yields.

"Credibility is also a big factor," says Charles Carlson, a contributor to the Dow Theory Forecasts newsletter and editor of the DRIP Investor newsletter. "Dividends come out of real earnings, " Mr. Carlson says, so if you are getting a cash dividend, you know that it is not being created with "accounting shenanigans."

Besides buying individual stocks, investors can also tap into dividends through mutual funds, such as the Fidelity Dividend Growth Fund or the Hartford Dividend and Growth Fund. So far this year, dividend-oriented funds are ahead of the broader market. An analysis of 13 funds linked to dividends, shows them to be down 13 percent through Sept. 16, compared with a 24 percent drop in the Standard & Poor's 500 index.

In other words, dividends can act as a cushion against falling stock prices, Carlson notes. That assessment is backed up by Dow Theory Forecasts, which reports that so far this year, individual dividend-paying stocks in the S&P 500 are down about 9 percent, compared with three times that amount for nondividend stocks.

People buying dividend stocks, says Lisanti, should look for companies unlikely to slash their dividends or scrub them altogether if economic conditions worsen.

And watch out for firms that suddenly boost dividends or raise them far higher than those paid out by competitors, Lisanti says. Such tactics aim to pull in investors and probably won't last, he says.

Instead, look for companies that have repeatedly raised their dividends over time. One example Lisanti gives is Johnson & Johnson; another is Alltel, a telecommunications firm.

Finally, to avoid annual taxes on dividends, experts recommend dividend paying stocks be held in sheltered accounts, such as an IRA or a 401(k) plan.