February was standout month for dividends

Eileen Ambrose -- Personal Finance

March 09, 2010|By Eileen Ambrose Personal finance

After two of the worst years ever for dividends, payouts to shareholders are making a comeback.

February was the best month for dividends in a long while, a sign that companies are feeling more comfortable that the economy - and their own fortunes - are recovering.

"Companies generally aren't going to start increasing dividends unless they have some confidence that they will be able to fund that rising dividend stream," says Chuck Carlson, author of "The Little Book of Big Dividends."

Companies, particularly banks, started slashing and eliminating dividends in fall 2008 when the stock market crashed. For 2008 and 2009 combined, companies in the S&P 500 index reduced dividends by a record $88 billion, according to Standard & Poor's.

"You haven't seen cuts on that type of scale since 1937 and 1938," says Josh Peters, editor of Morningstar's DividendInvestor newsletter. General Electric, for instance, cut its dividend last year for the first time since 1938.

"That really underscores the breadth and depth of the kind of downturn we were dealing with a year ago," Peters says. "We had a lot of companies used to enjoying steady cash flow and comfortable with their capital structure all of a sudden in panic mode."

But the fear seems to be subsiding. Though companies often announce dividend increases in February, last month stands out. Forty-seven companies raised dividends and one cut, says Howard Silverblatt, S&P's senior index analyst. A year earlier, 30 raised and 23 lowered dividends

The decreases have been particularly devastating. The single dividend decrease last month amounted to $28 million, a pittance compared with $19.4 billion worth of cuts in February 2009, Silverblatt says.

The benefit of dividends is that even if the stock price doesn't go up, you get something back on your investment. And the impact of these quarterly payments from companies shouldn't be underestimated. In the past 20 years, dividends accounted for 28 percent of an investor's total return, Silverblatt said.

On top of that, companies that pay dividends tend to be mature and their stock less volatile in bad times - something risk-averse investors can appreciate.

If you want to become an investor of dividend-paying stocks, here are some caveats:

•Make sure you want to own the stock in the first place and that it fits in your overall portfolio. Dividends are generally paid out quarterly, so you must stick with the stock for the long haul to reap the benefit of the payouts.

•Don't chase yield. The yield is calculated by dividing the dividend by the stock price. So, if the annual dividend is $2 and the stock price is $40, the yield is 5 percent.

The typical dividend yield now is 2 percent. Look for companies offering above-average yields of, say, 3 percent or 4 percent, but be wary of those offering double-digit yields, experts say.

A company offering unusually high yields may not be able to sustain that payout for long. And a high yield could indicate a falling stock price. In the above example, if the stock price falls to $20, the dividend yield is suddenly 10 percent. But who wants a stock that's tanking?

One warning: Most dividends are federally taxed at 15 percent. This favorable tax treatment expires at the end of this year. The expectation is that the rate on dividends could go up to at least 20 percent.

For many investors, though, that will still be lower than the ordinary income tax rate on interest from certificates of deposit and money market accounts, Carlson says.

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