Now Maybe It’s Time To Dive Into Dividends

Windowofworld.com – Soaring tech stocks led the longest bull market in history during the 1990s, prompting investors to avoid shares of companies that pay dividends.

The stable stock performance of the more conservative companies appears pale in comparison. But now, rising interest rates and slowing corporate earnings are causing investors to turn back to the tried and true: high-quality companies with strong cash flows, solid earnings and healthy dividend flows.

Companies that can commit to paying regular dividends are those that are fundamentally strong and optimistic about their future. The company’s dividend history is a good indication of its willingness to share profits and demonstrates accountability to investors. In a period of market uncertainty, this quality becomes very attractive to investors.

Stocks of companies that pay dividends generally have less price fluctuation than stocks of non-dividend payers. Dividends can create a cushion and smooth the volatility of stock prices. However, it’s important to remember that while dividend-paying stocks can add diversification to your portfolio and help minimize volatility, they carry some risk.

The 2003 Tax Law added allure to dividend-paying stocks. This lowers the tax rate for individuals on eligible dividends from as much as 38.6 percent to just 15 percent, depending on your income tax bracket.

This dividend appreciation has spawned renewed interest in dividend-paying mutual funds such as the American Century Equity Income Fund (TWEIX), which has been investing in dividend-paying stocks for more than a decade. Mutual fund companies are typically well-established and fundamentally strong, have steady income, solid balance sheets, and a history of dividend payments.

The dividend size also increases. Three-quarters of companies in the S&P 500 Index paid dividends, and more than half increased payouts during 2004. That’s evidence of many strong balance sheets. The business must have the income to pay dividends and a strong balance sheet to increase it.

Investor preference for dividend-paying stocks is likely to continue, and so will the ability of many companies to continue to pay dividends. The economic uncertainty over the years has pushed companies to cut costs, reduce debt and control their capital expenditures. That means many of them now have a lot of cash on their balance sheets.

This combination of lower debt and a larger pool of cash gives them the ability to increase dividends. Even with the current emphasis on returning more money to shareholders, the current dividend payout ratio is still below historical averages.