Dividends return

More companies responding to investors' demands for bigger share of corporate profits


Cash, that most coveted of goods, is in large supply these days behind the walls of corporate America.

Collectively, the 375 corporations that make up the Standard & Poor's industrials index, among the largest in the country, are sitting on a record $643 billion in cash and cash equivalents, S&P recently reported. All that cash, equal to about 7.4 percent of the underlying issues' total market value, is a product of three straight years of double-digit earnings gains.

"It's an enormous amount of money," said Howard Silverblatt, S&P's senior index strategist. "It's unprecedented."

As one might expect, investors have been clamoring to get their hands on more of it. And over the past three years, corporate America's more than two-decade retreat from paying a dividend has begun to reverse.

The case for dividends received a boost last month when reduced tax rates on capital gains and dividends were extended through 2010, rather than being allowed to expire after 2008. And that would move more corporate management teams to issue or increase dividends, said Duncan Richardson, chief equity investment officer at Eaton Vance Corp. in Boston.

Yet even as more firms have responded to calls to return more of their excess cash, dividend yields are far less than what they used to be, reports S&P. Since 1997, average yields -- the dividend payouts over 12 months divided by the stock's price -- have remained below 2 percent. Yet since 1926, dividend yields have averaged 3.8 percent.

Companies are also paying out less money as a percentage of earnings. Today, the payout ratio among S&P 500 companies is about 32 percent. But between 1950 and 1989, the dividend payout ratio of the S&P 500 index averaged 50 percent and never dropped below 38 percent.

"Considering the amount of cash companies have, there's still a ways to go," said Peter Boockvar, an equity strategist at Miller Tabak & Co., a boutique trading house.

Less volatile

A more modest economic outlook and an iffy stock market could heighten the attractiveness of dividend-paying stocks. Silverblatt said those stocks generally don't rise as much during good years as nonpayers, but don't fall as much during down years.

In May, a month when the S&P 500 fell 3.1 percent, stocks that pay a dividend dropped 2.3 percent while nonpayers fell 4.7 percent, S&P reports.

"Dividend payers have a bit of an anchor with them," Silverblatt said. "Investors are looking for a downside protection and so they're turning to dividend-paying stocks."

Investors are also looking for mutual funds that specialize in dividend-payers, said Josh Peters, equities strategist at Morningstar Inc. Among the better-known names are the T. Rowe Price Equity Income Fund and American Funds' Washington Mutual. Peters said both funds prefer higher-yielding stocks.

The iShares Dow Jones Select Dividend Index Fund is one of a handful of exchange-traded funds that track dividend-oriented indexes. But, Peters said, because these funds generally pick stocks offering high dividend yields, usually above 3 percent, the funds might not grow as fast as the S&P 500 index over the long term.

"I think a better way to play dividends is to look for stocks with long track records of annual increases and yields at or above the market average, around 1.8 percent," he said.

Some of Peters' favorites include Johnson & Johnson, Sysco, Bank of America, Wells Fargo and Coca-Cola.

Time was when quarterly dividends were an integral part of owning a stock. For decades, Eaton Vance's Richardson said, equity investments were widely viewed as a cash vehicle, not as a means of capital accumulation. Owning stocks was more about a steady source of income than long-term appreciation.

But in the 1980s and 1990s, the dynamics of the market changed as investors went in search of growth companies. During the Internet boom, when the Nasdaq composite index soared, firms paying a dividend were seen as laggards.

"Dividends were scorned for quite a while," Richardson said. "It's been a long time since we thought of equity investing in terms of a quarterly cash payment."

In 1980, the number of corporations in the S&P 500 paying a dividend was 469. By the start of 2002, that number had fallen to 351. Since then, the total has increased to 385.

The upturn in dividends is due in part to the emergence of shareholder activism, Richardson said. The passage of the Sarbanes-Oxley Act of 2002, he said, gave shareholders greater cause to be more involved in management decisions.

"The general message to corporate America was `improve your corporate governance,'" Richardson said. "And part of that meant putting a cash dividend on the same level as share buybacks."

Over the past three years, corporations have tended to use their excess cash to buy back their own shares. Not only do buybacks hold the potential to bump up a company's stock price, they have the added effect of making a company's per share earnings rise as well.

Sitting tight

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