What do anchors and dividends have in common?
An anchor, by its figurative definition, is “something that makes a person feel safe and secure.” That’s precisely what dividend-paying stocks/funds should do for investors. Kiplinger’s Steven Goldberg captures this sentiment by writing in the magazine’s March issue that “in today’s uncertain times, people like the security that only cash dividends can provide.”Why, after so many years of neglect, should investors be concerned about dividends? Many observers on Wall Street are forecasting single-digit equity returns for the foreseeable future. When compared to high-growth, 10 percent-plus historical stock gains, the forecasted 7 percent to 8 percent gains look disappointing. But such forecasts are not overly pessimistic. Isn’t it logical to assume that investment returns might cool down for the rest of this decade after the boom years of the 1990s?While remaining a long-term optimist about the benefits of equity investing, I do think it’s time for investors to become more focused on the components of an equity investment’s total return (see last week’s column). Rather than just looking to price appreciation, dividends should be considered an increasingly important part of the total return equation.Changing dividend scene As measured by the average dividend yield of the S&P 500 Index, currently 1.8 percent, dividend returns don’t look very exciting. However, there are high quality individual stocks and funds that do much better than the average. And dividend-payers are making a comeback. John Spence, of CBS MarketWatch, recently reported that “so far this year 74 stocks have upped their dividend rate versus 52 during the same period last year, and 41 in 2003.” Also, he added that the S&P 500 reports that currently the index has 378 dividend-paying companies compared to 351 at the end of 2002.Spence also highlights an important point for investors: In 2004, S&P dividend-payers “returned 18.4 percent compared with a 13.7 percent gain for non-payers.” This result is not surprising – numerous research studies have confirmed that, over time, dividend-paying stocks tend to outperform the non-payers.Significance of dividend rate increasesA 2 percent, or even a 3 percent dividend rate on an equity investment might not seem like much today, but steady dividend-payers tend to keep increasing their payout rate over time. Patient buy-and-hold investors can see their cost-yield climb significantly with the passage of time. There are numerous blue-chip companies that had dividend yields in the 2 percent to 3 percent range in the early 1990s that have now climbed into the 6 percent to 7 percent cost-yield range as of year-end 2004. Some experts are calling these high-income stocks the “new bonds.”What dividends sayGenerally, a dividend-paying company is characterized as a solid, steady performer with a low level of debt and reliable earnings. Paying dividends imposes a discipline on company management, and while no dividend can be guaranteed, management is generally very reluctant to cut its dividend or to drop it entirely.Dividends are tangible evidence of management’s ability to generate profits and return value to shareholders. Many investment professionals view stocks with strong and/or rising dividends as representing successful companies that are sending positive signals to the market in anticipation of improved future earnings.About this time last year, author and investment analyst James Glassman wrote in a Washington Post article that investors had not yet realized the benefits of owning dividend-paying stocks. What he said then still applies: “As they wake up, they will get hungrier and hungrier for such companies, whose shares may rise at a higher rate than the market as a whole.”For all the reasons I’ve mentioned, investors need to seriously consider “anchoring” their investment portfolios with some good dividend-paying stocks and mutual funds.The Investing Wisely column is written by Richard Loth, managing principal of Mentor Investing. He is an independent registered investment adviser. Loth can be reached at 827-5591 or email@example.com.Vail, Colorado