Mortgage mess leads to cuts in dividends

PERSONAL FINANCE

May 04, 2008|By EILEEN AMBROSE

Dividends might be in for their worst year ever.

The number of companies slashing dividends is up, while fewer are raising them. And the steepest cuts come from the financial sector, which usually accounts for more than a quarter of dividend payouts.

In further fallout from the subprime mortgage mess, 15 financial companies in Standard & Poor's 500 index decreased or suspended dividends this year.

That might not sound like much. But those cuts represent $9.96 billion that would have gone to shareholders this year, says Howard Silverblatt, S&P's senior index analyst. That amount is about 6 percent of the government's economic stimulus package, he says.

"We have never seen anything as bad as this" in sheer dollars, Silverblatt says.

You might dismiss dividends - cash usually paid out to shareholders quarterly - as something for retirees needing a steady stream of income. That would be wrong. Dividends on average have accounted for 22 percent of the total return on stocks in the past 20 years. They cushion a portfolio when the stock market is in turmoil, like now when all three major indexes are negative for the year.

And, most dividends for most investors are no longer taxed as regular income but at a low rate of 15 percent. (This favorable tax treatment expires after 2010, and what Congress and a new president will do then is unclear.)

Josh Peters, editor of Morningstar DividendInvestor newsletter, has been a fan of dividends for years despite being nowhere near retirement age.

"I'm a 61-year-old brain in a 31-year-old body," he says. "To me the biggest advantage of a dividend is it gives you a cash return that is always positive and never depends on the market price." And most dividends, he says, tend to rise over time.

Silverblatt says we might be near or at the end of the bad dividend news. Indeed, not every company is conserving its cash and being stingy with shareholders.

As of last week, 117 companies in the S&P 500 index - including IBM and Exxon - raised their dividends this year. That's a total of $9.18 billion in extra dividend dollars for shareholders, Silverblatt says.

If shopping for dividend-paying stocks, remember that the stocks should fit your portfolio and be shares you want to own for the long term.

You'll tend to find dividends at well-established companies. Newer companies usually use their cash to build their businesses, and if successful, their shareholders are rewarded with a higher stock price.

Dividend-paying companies are often found in industries such as utilities, energy, industrials, health care and consumer staples. Real estate investment trusts, which own and manage properties, distribute most of their taxable income in dividends to shareholders. REIT dividends, though, are taxed as ordinary income.

Financial stocks, of course, have been the big dividend distributors and where most of the cuts are now coming. National City Corp., for example, cut its dividend twice this year. The quarterly dividend is now a penny per share.

But you can find banks that didn't get entangled in the subprime mortgage mess and still pay good dividends, Peters says. One example, he says, is BB&T.

The North Carolina-based bank boasts on its Web site that it has raised its dividend for the past 36 consecutive years. And the bank's chief executive said last month that he expected another dividend increase this year.

Dividends are usually discussed in terms of yield, which is the dividend divided by the stock price. If the annual dividend is $1 per share and the stock price is $20, that's a 5 percent yield.

Don't pick a stock because it has an off-the-chart yield. Not only might that high yield not be sustainable, but it might just mean a falling stock price. And that's not good. If that $20 stock falls to $10, for instance, then suddenly the $1 dividend has a 10 percent yield.

Look for a company with a long track record, say 10 years, of annually raising dividends, Silverblatt says. Once companies establish a pattern of raising dividends, that's built into their stock price. And they're not likely to risk hurting that stock price by not raising their dividend, he says.

You also want to make sure that the company has sufficient earnings to continue the dividend.

Compare the dividend to the earnings per share, says Chuck Carlson, chief executive of Horizon Investment Services in Indiana. For example, if the dividend is $1.99 per share and earnings are coming in at $2 per share, that doesn't give the company much cushion to maintain that dividend, he says.

If you don't want to pick individual stocks, you can invest in equity-income mutual funds or exchange-traded funds that focus on dividend-paying stocks. These funds usually try to provide a healthy stream of dividend income on top of a rising share price over time.

But you should check the holdings in these mutual funds or exchange-traded funds before investing. They could be heavily invested in some of the very financial companies that are now struggling and cutting dividends, says Jeffrey Ptak, director of ETF research at Morningstar. That could drag down the dividend income stream and the share price, he says.

eileen.ambrose@baltsun.com

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