Yield of dreams

Dividends are more fruitful thanks to tax cuts

Your Money

August 15, 2004|By Andrew Leckey

Not every sexy makeover is on reality TV.

ThereM-Fs one going on right now in the stock market.

Stocks that pay dividends used to attract mostly older Americans on fixed incomes patiently awaiting payouts from sturdy utility stocks.

A transformation of the stock dividend from duckling to swan occurred when Congress approved President BushM-Fs tax cuts last year. The top tax rate on dividend income dropped to 15 percent from 38.6 percent, retroactive to the beginning of last year.

Dividends suddenly became a hot attraction for average investors. The typical company issuing them is also considered a catch: cash-rich with a stable reputation. In a hesitant market, dividends give investors something extra in their pocket while they wait for the real action to begin.

MicrosoftM-Fs $32 billion one-time dividend payment of $3 a share and doubling of its regular dividend to 32 cents a share spotlighted this environment favorable to dividends, but the love fest has been widespread.

Popular companies such as Wal-Mart Stores and PepsiCo have increased their dividends, and Outback Steakhouse, FedEx and others have offered dividends for the first time.

M-tThe market recovery had favored lower-quality, lower-priced, lower-dividend companies, but weM-Fve recently seen that mind-set change,M-v said Richard E. Cripps, chief market strategist for Legg Mason Wood Walker in Baltimore.

M-tThe S&P 500, representing bigger companies with higher dividend yields, drew closer in performance to the Russell 2000 and is now outperforming it.M-v

Yet dividends could lose their good looks if the current tax treatment fades away.

Democratic presidential candidate John Kerry has said that as president he would seek to repeal capital gains and dividend tax cuts M-tto the extent that such income causes a familyM-Fs income to exceed $200,000.M-v

Long-term capital gains for such families would be taxed at 20 percent or, if assets were held for more than five years, at 18 percent. Dividends would be taxed at a familyM-Fs marginal income tax rate.

M-tCompanies are looking to pay out more dividends, especially in this election year, because Senator Kerry is on record as saying heM-Fd be rolling back the tax cuts,M-v said Martin Nissenbaum, national director of personal income tax planning for Ernst & Young LLP in New York. M-tYouM-Fre certain your dividends now will qualify for the new lower rate this year, while no one really knows what will happen after the election.M-v

Even with a Kerry White House, a rollback of the dividend tax cut isnM-Ft certain.

M-tIf Kerry becomes president, heM-Fd need a Democratic majority in the Senate and possibly even in the House, which isnM-Ft likely to happen,M-v said Sam Stovall, chief investment strategist with Standard & PoorM-Fs in New York. M-tHeM-Fd need more votes than heM-Fs probably going to get in order to overturn President BushM-Fs tax plan.M-v

The average dividend yield for S&P 500 stocks is 1.79 percent, compared with 1.1 percent in March 2000. Fast-growing industries such as technology have traditionally plowed their cash into research and development, not payouts to shareholders.

M-tThere is no free lunch, so a stock with a dividend 2 to 3 percent higher than the average yield for its sector can be an indication investors donM-Ft think that dividend is sustainable,M-v warned Charles B. Carlson, editor of the DRIP Investor newsletter (www.dripinvestor.com) in Hammond, Ind.

M-tYouM-Fre best off focusing on stocks with decent yields and nice dividend growth, as opposed to buying the highest-yielding stocks.M-v

Carlson and Cripps recommend shares of Bank of America (ticker BAC), whose recent

dividend yield

was 4.29 percent. The bank increased its dividend by more than

10 percent each year for the past decade and just raised it another 15 percent this year. Its merger with

Fleet

Financial has made it a national business growing at a solid clip.

Wells Fargo (WFC), recently 3.4 percent, is another favorite Carlson banking stock, while his top energy picks are ChevronTexaco (CVX), recently 3.34 percent, and ConocoPhillips (COP), recently 2.27 percent.

CrippsM-F favorite dividend-paying stocks are Alltel (AT), recently 2.87 percent, and General Electric (GE), recently 2.48 percent.

Maintaining dividend yield is a priority.

The highest-yielding stock on the S&P 500 is a real estate investment trust, Equity Office Properties (EOP) of Chicago, recently yielding 7.59 percent. REITs, which manage real estate properties, must distribute at least 95 percent of their income.

Although declining rents and occupancies at office and industrial properties will leave Equity Office Properties $179 million short of covering its dividend, it has no plans to cut it. Chief Financial Officer Marsha C. Williams said thereM-Fs enough cash on hand and that a dividend cut wouldnM-Ft make sense with office markets beginning to recover.

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