Cash-heavy firms slow to raise dividends

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January 07, 2007|By Tom Petruno | Tom Petruno,Los Angeles Times

Investors in Mattel Inc., McDonald's Corp. and Home Depot Inc. got hefty cash bonuses last year. All three raised their dividend payments 30 percent or more.

But corporate generosity with dividends overall didn't live up to some analysts' expectations.

That is stoking concern about the outlook for payouts this year and beyond at a time when the growing ranks of retirees might have more need for rising income from their stock investments.

"We thought companies would do more" with dividends last year, given corporate earnings' surge to record highs, said Howard Silverblatt, a senior analyst at Standard & Poor's in New York.

Yet within the blue-chip S&P 500 index, the number of companies raising or initiating dividends totaled 304 last year, down from 317 in 2005. That breaks a strong uptrend in place since 2003, when 267 of the companies in the index lifted or initiated payouts.

Dividends had been rising in recent years as corporate earnings boomed amid a global economic expansion. Dividend payments typically improve with companies' fortunes.

Corporations have had another incentive to lift their cash payouts to investors. Congress in 2003 slashed the top federal tax rate on dividend income to 15 percent from 35 percent, making dividends much more lucrative for many shareholders.

The decline in the number of blue-chip dividend increases this year might stem in part from corporate fears of slower earnings growth in 2007 and a weaker economy. Companies often hesitate to commit to bigger dividends when they expect their earnings growth to decelerate, because dividends generally are paid out of retained profit.

But something else is holding back dividend increases, analysts say. Instead of paying more cash directly to shareholders, many companies are spending record sums to buy back stock.

In theory, buybacks can help push up stock prices, rewarding shareholders with capital gains. And by reducing the number of shares outstanding a company can boost its earnings per share, potentially making its stock more valuable.

Still, those are just possible effects - whereas a dividend payment is cash in investors' pockets.

S&P 500 companies shelled out $110 billion for stock buybacks in the third quarter, twice what they paid in dividends, S&P data show.

"We are concerned that the large expenditures on buybacks may be inhibiting dividend growth," Silverblatt said.

He noted that companies can suspend buyback programs at any time. Dividends, by contrast, tend to represent a long-term commitment from a company to its shareholders; most firms are loath to cut payouts because of the negative message that would send investors who have gotten used to the income.

Jack Ablin, chief investment officer at Harris Private Bank in Chicago, said he generally prefers dividends to buybacks. It makes sense for a company to use cash to buy back its stock, he said, if the shares are trading for less than the company's net worth, or book value - meaning assets minus liabilities. But with the S&P 500 index near a six-year high, "very few stocks are trading below book value," Ablin said.

"It's maddeningly frustrating to me that corporations are hoarding cash and sitting there," he said.

Some Wall Street professionals believe that retiring baby boomers increasingly will turn to stocks of companies that raise dividends at least once a year, as a way to get income growth that fixed-rate bonds or bank accounts can't provide.

Pension funds also might have to rely more on rising dividends to meet their obligations, particularly if bond yields stay relatively low, analysts say.

"What gets us excited about dividends is that we think we're entering an environment when they will be valued more" by investors, said Doug Sandler, chief equity strategist at brokerage Wachovia Securities in Richmond, Va.

That could mean higher prices, over time, for dependable-dividend shares than for companies that have similar growth prospects but aren't as forthcoming with cash payouts, he said.

Tom Petruno writes for the Los Angeles Times.

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