WHY DIVIDENDS NOW

Christopher MarkowskiArticle, Financial PlanningLeave a Comment

Shifting Preferences and Corporate Policy

In the 1960s and 1970s, companies paid out a significant portion of their earnings in dividends, as investors exhibited a strong preference for income. However, in the 1980s, and even more so in the 1990s, investors became unenthusiastic about dividend yields because they were dwarfed in size by the massive capital appreciation most stocks experienced. As a result, many companies altered their dividend policies to reflect investors’ changed preferences, opting instead to repurchase outstanding stock or reinvest in the company rather than pay income to shareholders.

However, the coming decade is shaping up to be a very different environment, one in which investors will once again favor dividends. Here are a few important reasons why:

1. Uncertain capital appreciation. After years of double-digit returns that exceeded historical norms, the stock market, as measured by the S&P 500 Index, produced negative returns in both 2000 and 2001. Looking ahead, many strategists are predicting that the next several years will see positive but muted market returns. In such an environment, we anticipate that dividend yields will become more important to investors because they will comprise a larger portion of total return.

2. Low interest rates. With certificates of deposit, money market accounts and bond yields all providing relatively low yields, stocks with significant dividend yields in addition to offering the potential for capital appreciation are looking very attractive.

3. Lower volatility. The reality of generating dividend distributions is that investors are being “paid” some of their return up front, which reduces the duration of the investment. A reduction in duration usually leads to lower volatility, and this has historically been the case with dividend paying securities.

4. Lack of confidence in corporate accounting procedures. After some high-profile corporate blowups such as Enron, investors have become distrustful of corporate accounting methods. We believe investors will favor dividend-paying stocks because they are a tangible form of earnings and cannot be manipulated.

In conclusion, we think there are many attractive opportunities among dividend-paying securities—and we are finding them in areas as diverse as real estate investment trusts (REITs), utilities, convertible bonds, and higher-yielding Dow stocks. In the current market environment of uncertainty, dividend-paying stocks have held up well—and we think they could continue to outperform as more and more investors recognize the value of income.

 

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