Stocks paying dividends can provide a cushion

Dollars & Sense

October 07, 2001|By EILEEN AMBROSE

STOCK dividends are sort of the macaroni-and-cheese comfort food of investing. And these days, with investors facing another year of negative stock market returns, many of them could use a little comfort.

"It's nice to look at your statement and see what your dividends were, even if the stock is going down," says Baltimore investor India Lowres. "Psychologically, it's a great thing."

Dividends can be a good thing for investors' portfolios, too. A recent study found that in down markets from 1970 through last year, dividend-paying stocks outperformed those that didn't pay dividends by 20 percent to 30 percent, thanks in part to the payouts.

"If we go through a number of years of more modest returns, [dividends] can be a critical piece to overall performance," said Tom Huber, portfolio manager of the T. Rowe Price Dividend Growth fund in Baltimore.

Even excluding dividends, dividend-paying stocks can provide a haven in turbulent markets, experts said.

From the end of 1999 through last month, the stocks in the Standard & Poor's 500 index that pay dividends rose an average of 2.02 percent, not counting dividends.

That compares with an average drop of 26.21 percent by S&P 500 stocks without dividends, typically technology stocks that have been beaten down, said S&P's Howard Silverblatt.

Dividend-paying stocks tended to do better because of the types of companies that pay dividends, experts said.

"The companies that pay high levels of dividends are more mature, stable companies and tend to be less speculative," said Rob Arnold, who co-manages the Delaware Growth and Income fund in Philadelphia. "So, when the market environment is difficult or we're in a bear market, these more mature companies ... get rewarded by declining less and going up."

Besides providing a cushion in a down market, dividend-paying stocks can also help diversify portfolios, said Denise Leish, a money manager with Money Plans in Silver Spring.

"If one is looking for income and just has a bond portfolio, it's a way to get equities in the portfolio, and you have the opportunity to get some appreciation in those equities," Leish said.

It wasn't so long ago when stocks were soaring to new heights and dividends were a low priority for investors. Seeing their stocks appreciate by 20 percent to 30 percent or more each year, many investors didn't care whether they earned an extra 2 percent from dividends or not, experts said.

Another reason dividends' appeal diminished is that they are taxed as income. Many investors' income tax rate is higher than the rate on capital gains when appreciated shares are sold.

The trend for years has been fewer dividends and fewer increases, experts say. At the end of last month, 359 companies in the S&P 500 paid dividends, with an average yield of 2.2 percent. A decade ago, 437 companies in the index paid dividends for an average yield of 3.24 percent.

Lowres, the Baltimore investor, learned to appreciate dividends from her father, who retired in his early 40s and later in life lived off the dividends earned on utility stocks.

When she became an active investor 10 years ago, Lowres started with a utility stock. She has since added more utilities to her portfolio and expanded into blue-chip growth stocks. She also admits to getting swept up in the high-tech euphoria of the late 1990s.

"Believe me, I bought a few things that I am not so happy about - Amazon. I don't care what they say, it's never coming back," said Lowres, senior associate director of alumni relations at the Johns Hopkins University.

But the 47-year-old held on to her utilities, which tended to pay high dividends, and other dividend-paying stocks. Last year, when all three major stock indexes lost ground, Lowres' portfolio rose 11.8 percent, including dividends.

"I beat Bill Miller," she said, referring to the Baltimore money manager renowned for beating the S&P 500 index 10 years in a row. Miller's Legg Mason Value Trust fund fell 7.14 percent last year.

This year, Lowres' portfolio is down 1.5 percent. That's still a better return than the market overall.

Yet, experts warn against going overboard by investing exclusively in dividend-paying stocks.

In up markets, small and large companies that don't pay dividends tend to outperform dividend-paying stocks by 15 percent to 20 percent, said Kathleen Fuller, a University of Georgia finance professor who co-authored the study on dividends' impact over three decades.

"That's why I don't think any one person should sink all of their money in dividend-paying stocks," Fuller said. "In those up markets, you may do better in the nondividend-paying stocks."

Investors searching for dividends are likely to find high yields from real estate investment trusts, which must distribute most of their taxable income to shareholders each year, and utilities. Other sectors paying healthy dividends include retail, oil, tobacco, pharmaceuticals and financial services, experts said.

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