I ran across an article from the May issue of Kiplinger Personal
Finance discussing the wisdom of investing in dividend-paying stocks.
The information in the article is pretty well-covered territory at
Foothills Financial Planning, but a sub-article covering Why Dividends
Matter almost sounded like an advertisement for the Camelback Fund, so I
decided to summarize the high points.
article points to five reasons to favor dividend paying companies,
using Procter & Gamble as a representative stock. For purposes of
full disclosure, P&G is not currently a holding of the Camelback
Fund, but it is a significant holding in Warren Buffett’s Berkshire
Hathaway portfolio, and it has a lot of the characteristics we look for
in evaluating candidates for the Camelback Fund.
The high points:
Dividends are big drivers of stock returns
the S&P 500 is currently yielding less than 2%, dividends have
accounted for 43% of the market’s long-term return of nearly 10%
annually. At the time of the article the yield for the S&P 500 was
1.9%, and we’re not far off of that right now.
Dividends can grow
companies make it a practice to increase their dividend on a regular
basis, typically annually or every other year. Owning these shares on a
long-term basis not only ensures that the investor receives the
dividend income he or she signed up for, but also that the income will
grow over time as the dividend grows. In contrast, the interest payment
on bonds - which are another place income-seekers look for a steady
paycheck - will never increase. This is a particularly important issue
when inflation is factored into the equation. The fact that P&G has
raised its dividend an average of 10% per year for a very long time
provides reassurance that the income provided from such an investment
will outpace inflation in most economic environments.
Dividend-paying stocks enjoy a tax advantage
least through the end of 2010, dividends are taxed at a 15% rate for
taxpayers in most tax brackets, while ordinary income can be taxed at a
rate as high as 39.6%. Those in the 10% and 15% brackets pay no tax on
be clear, the current favorable tax treatment for dividends is set to
expire at the end of 2010. Lately, there has been a lot more indication
that they may be extended for a year or two, at least for most
taxpayers, but that is far from a done deal. If the tax treatment does
expire, rates will return to the rates paid on ordinary income.
worth noting that the out-performance that has been attributed to
dividend stocks has mostly occurred during times when they were taxed at
ordinary income rates, rather than the current lower dividend rate.
Nonetheless, the more that goes to taxes, the less the investor keeps.
Dividend-paying stocks tend to be less volatile than non-dividend stocks
the stock market as a whole has been very volatile in recent times, and
dividend payers have not been entirely exempt from that volatility,
they tend to move up and down less than the overall market. One
backward-looking measure of volatility is beta, which in this case
typically refers to how closely a stock tracks with the S&P 500.
The article points out that dividend-paying stocks as a whole (i.e.
those that pay dividends, big or small) tracked pretty closely over the
past 5 years, with a beta of .98. However, Proctor and Gamble’s beta
was only .55.
Bad markets treat dividend-paying stocks more kindly
stocks tend to maintain their value in down markets more than their
non-dividend paying brethren. Perhaps the most eye-opening bit of data
offered in the article is the fact that dividend-paying stocks lost only
10.9% in 2002, just after the bursting of the dot com bubble. By
contrast, non-payers dropped 30.3%! In fact, P&G actually gained
9.4% in 2002.