Paying Up

Last year the S&P 500 index was unchanged. But it had a total return of 2.1%. The difference is dividends—the cash that companies return to their shareholders. What’s more, stocks that pay dividends did better than stocks that didn’t. They went up 1.4%, on average, while dividend-free stocks declined 7.6%. Dividends are in fashion right now. What’s the attraction?

First, dividend yields are higher than bond yields. Ten-year treasuries yield less than 2%, and the S&P 500 yields more. If you depend on your portfolio for income, that cash return is attractive. Second, dividends usually increase, while bond yields are fixed, or tied to a short-term rate. And many analysts are predicting significant dividend boosts in 2012.

Third, dividends are a window into a company’s soul: they illustrate, as nothing else does, its commitment to shareholders. Dividends can’t be manipulated, like earnings. They can’t be manufactured by shipping products from one warehouse to another. They can’t be front-loaded or restated due to an accounting change. They represent cash in the wallet.

Stock buybacks also give cash back, but there’s a difference: buybacks reward stock sellers; dividends reward stock holders. Buyback programs can be cut or cancelled and almost no one notices; but if dividends are cut it’s a big deal. When management initiates or increases the dividend they’re making a long-term statement as to the company’s health. It’s no wonder investors find that attractive.

Over time, dividends have been a principal source of stock-market return. This isn’t going to change any time soon.

Douglas R. Tengdin, CFA
Chief Investment Officer
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