Dividend stocks gain investors

Your Money

January 14, 2007|By Carolyn Bigda | Carolyn Bigda,Tribune Media Services

Buy a stock and your reward (you hope) is an increase in the stock price as the company grows and appeals to more investors.

But some companies offer another incentive: They pay a dividend, or a portion of profits, to shareholders on top of any appreciation in the stock price. And in the past few years, these types of stocks have attracted many investors.

Unlike interest paid by bonds, a dividend is not a fixed rate, meaning companies can increase or reduce it. But it can help pad total return, the sum of the dividend and any change in a stock's price.

For example, the Standard & Poor's 500, an index of major U.S. stocks, increased 24 percent over the past five years. However, the S&P 500 total return index, which takes into account reinvested dividends, rose 35 percent, according to data from Thomson Financial.

A $10,000 investment would have grown to about $13,500 with dividends versus $12,400 otherwise.

Companies that pay dividends tend to be well established and have a steady record of profits. They're often categorized as value stocks, not growth stocks, which are businesses trying to expand rapidly and therefore are reinvesting most of their cash.

That's a reason dividend-paying stocks - and the funds that buy them - have been popular recently. After the dot-com bubble burst this decade, shareholders became wary of upstart businesses.

"Investors were burned, and companies that pay dividends tend to be more defensive in adverse climates," said Brian Rogers, manager of the T. Rowe Price Equity Income Fund, which invests in dividend-paying stocks.

At the same time, a federal law passed in 2003 capped the tax rate on dividends at 15 percent, down from as high as 38.6 percent.

As a result, dividends became more appealing to shareholders.

"They started to demand it," said Phil Davidson, co-manager of the American Century Equity Income Fund.

Should youfocus on buying dividend-paying investments? Some factors:

Balancing risk with return.

Stocks that pay dividends tend to be less volatile.

Growth stocks, while more risky, can benefit from major upswings. And as a young investor, with enough time to overcome setbacks, you could receive a higher return by being more aggressive. "Dividend-paying investments are probably less appropriate for young investors, except for conservative young investors," said Rogers.

Keep in mind that the market will not always favor dividend-paying stocks, despite their recent popularity. In fact, there is growing buzz among fund managers about growth stocks. "It's just the growth-value cycle that has gone on for years and years," Rogers said.

Expenses can eat into dividends.

On top of weighing risk versus return, you also have to pay attention to fund expenses, which can reduce a dividend's benefit, said John Coumarianos, a mutual fund analyst at Morningstar Inc.

The Fidelity Spartan 500 Index Fund, for example, has a yield of 1.54 percent, according to Morningstar. The yield is the dividend paid out over the past 12 months, divided by the stock's price. The Fidelity Equity-Income Fund came in just shy at 1.51 percent. The difference could be explained in part by the funds' expenses: The Index fund charges 0.10 percent, while you'll pay 0.67 percent for Equity-Income.

You might have dividend stocks.

Finally, you don't have to invest in a fund that solely picks dividend-paying stocks. An index fund that tracks the S&P 500 will hold a mix of growth stocks and dividend-paying stocks - which may be the blend you need.

yourmoney@tribune.com

Carolyn Bigda writes for Tribune Media Services.

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