Tuesday, January 17, 2012

Why Are Stock Dividends So Important?

by Robert B. Garey, Ph.D.

Retiring baby boomers need sustainable income that will keep up with inflation through 25 – 30 years or more of retirement. However, with interest rates on bonds and CDs at close to the lowest levels ever, people who are approaching retirement are wondering where in the world they can invest to accomplish this.

Recently, there’s been a growing interest in investing in stocks with high cash dividends. Dividends are the portion of corporate profits that companies pay out to shareholders. Not all companies pay dividends, and companies that do pay them can cut or eliminate them when times are bad. Many large companies, however, have a history of maintaining or raising dividends each year for several years.

Dividends have been an important component of the returns on U.S. stocks for decades, but for the last 20 years or so they’ve mostly been ignored. Very few people cared about stock dividends during the Internet market of the late 1990s or the real estate driven economy of the last decade. Now that yields on bonds and CDs are so low, and dividend-paying stocks are generally cheap, many investors are starting to look at the value of investing for dividend income.

What are the benefits of owning high quality dividend-paying stocks?

o Currently, dividends from large cap U.S. stocks have a higher yield than 10 year Treasury bonds. As of mid January, 2012, the dividend yield on the S&P 500 is about 2.2% which is slightly higher than the 2% you can get on 10 year Treasury bonds.1 Morningstar says that this differential hasn’t been as favorable for dividend-paying stocks since the 1950s.2

o Dividend-paying stocks offer the potential for both growth and rising income. According to Morningstar, “Since 1927, high-dividend-paying stocks have returned 11% a year, beating the 8% return on nonpayers…Better yet, they accomplished this feat while incurring less volatility”.3 Dividends have contributed 44% of S&P 500 returns during this period.4

o Historically, dividends have grown faster than the rate of inflation in the U.S. The rate of dividend increases is uneven year to year, and sometimes even declines, such as in 2009. On average, however, dividends rose 2.4% higher than the rate of inflation between 1947 and 2006.5

o Corporate profits are at record levels (even though the stock market isn’t), and many companies have the potential to increase their dividends. Right now, corporations are being cautious with their cash and paying out a lower than average percentage of their earnings in dividends.6 This provides the potential for future dividend growth.7


Next time: Ways to reduce some the risks of buying dividend-paying stocks.

Dividends are not guaranteed and are subject to change or elimination.

1Jeff Benjamin, “Dividend-Paying Stocks are Now Outperforming Bonds,” Investment News, 1-15-2012, http://www.investmentnews.com/article/20120115/REG/301159979
2Michael Rawson, “Our Favorite Dividend ETFs for 2012,” Morningstar, 1-11-2012, http://news.morningstar.com/articlenet/article.aspx?id=451284
3Ibid.
4Lance Paddock, “The Power of Dividends and What They Say About Future Returns,” Advisor Perspectives, 9-20-2011.
5Josh Peters (Morningstar), The Ultimate Dividend Playbook (New York: John Wiley & Sons, Inc.: 2008), pp. 91, 92.
6“Bonds and Dividend Stocks,” Smart Money, October 2011.
7Peters, op cit., pp. 95, 96.