The long-scorned dividend is soothing in painful times

July 03, 2002|By JAY HANCOCK

Communist light Friedrich Engels once complained that capitalists had no social function except "pocketing dividends, tearing off coupons and gambling on the stock exchange," but in the 1990s capitalists weren't even that busy.

They skipped the dividends and bond coupons and went straight to the gambling. As the Nasdaq stock index rose from 1,000 to 5,000, dividends became as scarce as savings-account passbooks. Most companies in the tech-swollen Nasdaq composite index paid no dividend, and the habit became infectious.

Nearly a third of today's S&P 500 stocks do not pay a regular portion of their profits to shareholders in the form of a check. By contrast, in the 1980s about 90 percent of S&P 500 companies paid a dividend.

Most dividends that have survived into the 21st century are puny imitations of their forebears.

Sixty years ago, the dividend yield on the S&P 500 was more than 5 percent, which was far above even bond payouts and reflected stocks' supposed high risk. Today it's 1.7 percent. The yield on the Nasdaq composite index is 0.4 percent.

But every wallflower gets its dance. Dividends are back on the floor.

The favored way to make money in the market in the 1990s was pure capital gain: having the price of your stock go up. The way to make money lately is the one your granddad preferred: collecting a quarterly portion of cash corporate earnings and hoping for price appreciation, but not staying up late waiting for it.

Reliable dividend stocks such as Merck, Philip Morris and Citigroup are on many "buy" lists. Dividend-paying shares in the S&P 500 have beat the rest of the index for two years in a row, according to Standard & Poor's.

For this year through mid-June, the median dividend-paying stock in the S&P 500 produced a total return of 1.4 percent, says Morgan Stanley, while S&P 500 stocks paying no dividends booked a median loss of 18.8 percent. Morgan Stanley said it was unable to give me year-to-date numbers through the end of June.

One factor helping bring dividends back in season are microscopic interest rates. With the two-year Treasury bill yielding 2.8 percent, stock in Bristol-Myers Squibb, paying a 4.6 percent dividend, doesn't look bad.

But there is another, more important force behind the dividend redux. In this time of suspicion and doubt, dividends have reassumed their ancient role as symbols of liquidity and probity.

In the 1800s, investors had no public quarterly earnings reports, no Securities and Exchange Commission, no insider trading laws and no benchmark for accounting standards. All they had were hunches, media hype and hot air from the stock promoters.

In that desert of regulation and truth, a dividend was a powerful sign of good management and a proven marker for distinguishing the gold from the mud. And so it has become again.

The dividend's comeback is even more impressive when you consider the brutal tax obstacles it must overcome. Dividend abuse by the Internal Revenue Service was a big reason the payments were spurned last decade.

Dividends are taxed once as corporate profit and again on the individual schedule as personal income. By eliminating dividends, corporations avoided the double-tax hit and often used the cash instead to repurchase their shares, which boosted earnings per share and so raised the stock price.

By participating in corporate profits through dividends, investors get taxed at 28 percent or even 39.6 percent on the personal schedule. By participating in corporate profits purely through stock appreciation, they pay nothing until they sell the stock, and then, only the 20 percent long-term capital gains tax.

But despite this disadvantage, "in a post-Enron world, dividends may signal a commitment to shareholders that has recently been lacking," points out Richard Berner, Morgan Stanley's chief U.S. economist.

Not long ago, dividends had a predigital, Rust-Belt taint to them, which supposedly accounts for Microsoft's refusal to pay any of its $40 billion in cash to shareholders. But now dividends are beaming a different message.

A company paying a 3 percent dividend is giving shareholders an immediate return on investment, a choice in how to reinvest corporate profits and a physical token of profitability, not just a bookkeeping entry that, as we have seen, may or may not be accurate.

A stock with no dividends says, "Trust me." A stock paying dividends says, "The check really is in the mail."

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