By Karyn McCormack
You can't find a clearer sign that a company is profitable, well-managed, and committed to sharing the wealth with shareholders than a long track record of paying dividends. If the company has also consistently increased the amount of cash paid out in dividends, that's all the better. Studies have shown that the shares of companies that pay dividends tend to beat those that don't, usually with a lot less risk.
With paltry returns available on savings accounts and a low 15% tax rate in place since 2003, investing for dividends "has really become the trend du jour," says Kelley Wright, managing editor of Investment Quality Trends, a newsletter that has been tracking dividends since 1966.
The number of companies boosting payouts has been on the rise. So far through Aug. 31 of this year, 217 of the S&P 500 companies have hiked their dividend, vs. 185 increases in the same period last year and 169 in the 2003 period. In all, 386 of the 500 companies in the index pay dividends -- that's 72% of issues, or 85% of the market's value, says Joseph Lisanti, editor of Standard & Poor's weekly investing newsletter, The Outlook. To find consistent dividend payers, check out the S&P Dividend Aristocrats -- companies that have regularly upped their payouts for 25 or more consecutive years.
Financial companies tend to pop up on lists of companies with rising dividends and high yields (see BW Online, 9/16/05, "Dividends with a Double Distinction"). That's mainly because that business doesn't require the high capital spending of other industries, so they can return the cash to shareholders, Lisanti reasons.
Citigroup (C ) is ranked 5 STARS, or strong buy, by S&P, and has raised its dividend by 239% over the last five years. "We like it even though the stock has been weak recently," Lisanti says. He thinks its diversified mix of financial businesses gives Citi strength.
Insurer Allstate (ALL ), also ranked a strong buy by S&P, has increased its dividend by 94% over the last five years, Lisanti says. As for exposure to Hurricane Katrina, Allstate's main business is writing homeowner's policies, which usually exclude flood coverage, so S&P thinks the claims will be manageable.
S&P also favors Procter & Gamble (PG ), which has increased its dividend by 67% over the last five years. "It has a phenomenal record -- it's up to 49 consecutive years of dividend increases -- one of strongest records that we're aware of," Lisanti says.
Wright of Investment Quality Trends tracks 350 dividend-paying stocks, 35 of which have earned a "G designation" (for growth) -- meaning the company has increased dividends by 10% a year for the last 12 years. The stocks that look most undervalued in this group include insurers AIG (AIG ) and Mercury General (MCY ), banks Bank of America and Citigroup, retailers Claire Stores (CLE ) and Wal-Mart (WMT ), and fast-food giant McDonald's (MCD ).
Jeff Kleintop, chief investment strategist at PNC Advisors has a favorite dividend-payer in several sectors. In finance, he cites Bank of America (BAC ), which boasts a very high payout that continues to increase. Its yield is 4.6%, and the bank has been increasing its dividend 13% a year for the last five years. Among industrials he points to General Electric (GE ), which has raised dividends by 10% a year for last five years. Its yield is 2.6% -- relatively high compared with 1.8% for S&P 500 companies.
Retailer Home Depot (HD ) doesn't have a huge dividend -- its yield is just 1% -- but Home Depot has hiked its payout by 19% each year for the last five years, says Kleintop. "It's being smart about what it's doing with its capital and giving some of it back to shareholders," he says.
In the health-care sector, Kleintop likes Johnson & Johnson (JNJ ), which has raised its payout by 15% annually over the past five years. The maker of medical devices and supplies, as well as pharmaceuticals, is well positioned to benefit from demographic trends and not as exposed to some of the risks to dividends faced by other drugmakers, he says.
In the technology sector, Intel (INTC ) was one of the first companies to pay a dividend. The chip giant has boosted its payout by 34% a year for the last five years, and the shares have a yield of 1.25%, Kleintop says.
Josh Peters, editor of Morningstar Dividend Investor newsletter has his own crop of picks. He's keeping his eye on Microsoft (MSFT ) for news about a dividend boost, he says. "We think it will raise its dividend by 25% a year."
London-based alcohol beverage giant Diageo (DEO ) is another name Peters says to watch. The owner of well known brands such as Smirnoff vodka, Johnnie Walker scotch, Guinness stout, and Baileys Original Irish Cream liqueur has been raising its payout by 7% each year.
If you don't want to pick your own dividend plays, another way to invest is through an exchange-traded fund (ETF). "Many investors, particularly baby boomers, are preparing for retirement and want income as part of a bigger portfolio," says Bruce Bond, president of PowerShares Capital Management. On Sept. 15, PowerShares launched three new ETFs that invest in companies that consistently raise dividends.
Dividend payments continue to climb, even as earnings growth remains robust. For the S&P 500 companies, dividend-per-share growth rate was 16% in the second quarter and 17% in the first. That compares to earnings-per-share growth of 12% in second quarter and 13% in the first, Kleintop says.
"What's interesting now is we're seeing a period where dividends are growing faster then earnings," says Kleintop. Usually, dividend-per-share growth exceeds earnings-per-share growth when the economy is in a recession, he notes. But he thinks the 2003 tax-law changes give companies good reason to continue boosting dividends to attract more shareholders.
Of course, if Congress doesn't vote to extend the dividend tax breaks, which are scheduled to expire at the end of 2011, the higher dividends trend could reverse. Plus, if short-term interest rates go much higher, bonds could once again become an attractive alternative to high-dividend payers, like utilities, crimping those share prices.
But Wright believes the capital appreciation you can get from dividend-paying stocks over time outweighs the risks of both higher rates, which tend to be temporary, and the possibility that Congress could change the tax code. A lot of pros think the tax code for dividends will stay.
No matter how you slice it, dividends can help cushion portfolios with income and may even provide some decent growth, too.
McCormack is senior producer for BusinessWeek Online in New York
Edited by Amey Stone