Dividends: Some Races Are Not to the Swift
From 1995 to 2000, dividends looked as if they were going the way of poodle skirts and pompadours. Fast-growing companies plowed their money back into the enterprise and rewarded their investors with more growth. Who could complain? Share prices were rising by 20% a year and more.
Small wonder investors forgot about dividend-paying stocks. "A company pays high dividends because its growth prospects have cooled and it can't think of anything better to do with the money," observes Steven J. Lehman, a portfolio manager at Federated Investors Inc.
With the cratering of such late- '90s growth-stock stars as Cisco Systems (CSCO ), Qualcomm (QCOM ), and JDS Uniphase (JDSU ), dividend-paying stocks are back in style. For starters, with short-term interest rates at 40-year lows, even a 2% dividend looks pretty generous. And investors have learned that in a bear market, a dividend from a solid company is one return you can count on. Indeed, according to a study by T. Rowe Price Associates, in the year 2000 the prices of dividend-paying equities in the Standard & Poor's 500-stock index rose an average of 3.1%; those that paid no dividends dropped by 39.2%. If nothing else, a company with a good track record on paying and increasing dividends probably is one with a good earnings history as well.
Consider the return from high-dividend stocks. The share prices for Philip Morris Cos. (MO ) is up 4% so far this year, but dividends have added an additional 5% to its overall return. Procter & Gamble Co. (PG ) is up just 2%, but with its dividend the total return is 4%. Meanwhile, the S&P 500 lost 15% of its value so far this year and yielded just 1.3% in dividends.
In the current market, some dividend-paying stocks are even competitive with traditional growth stocks (table). Take banking giant J.P. Morgan Chase & Co. (JPM ) It has a hefty 3.6% dividend yield and a history of increasing its payout 13% a year. Next, consider Tyco International Ltd. (TYC ), a conglomerate with an aggressive growth strategy. Tyco pays only a token dividend that it has never increased.
A few years ago, no one would have disputed that Tyco would provide a better total return to shareholders than a big bank. But take a look at the new math. As long as you reinvest the dividends in J.P. Morgan Chase stock, we estimate that in five years, the investment would be worth more than a comparable amount of money put in Tyco on a pretax basis. Since taxes on dividends are higher than on long-term capital gains, dividend stocks are less attractive in taxable accounts. But they work just fine in IRAs and other tax-deferred vehicles.
Our analysis makes several assumptions about dividend growth, earnings growth, and stock price appreciation. For dividends, we used the company's historic growth rate. For earnings, we used the five-year growth projected by Wall Street analysts, which we then sliced by a third, since they're always too high. We then assumed that the stock price would appreciate in line with earnings.
Bank stocks, such as Bank of America, J.P. Morgan Chase, and Wells Fargo (WFC ), are always good places to hunt for dividends. So are oil stocks. You also can get yield and modest growth from food and tobacco stocks. R.J. Reynolds Tobacco (RJR ) has an eye-popping 5.6% dividend yield. Price appreciation is likely to be slight, since analysts forecast only 10% earnings growth in 2002. If the stock goes up only 5%, the total return still reaches over 10%. Not bad for a low-volatility stock with a solid balance sheet.
For a clever play among the traditional high-yielders--utility stocks--consider TXU Corp. (TXU ) The Dallas-based power company boasts a 5.3% dividend yield and a history of growing it by 3.3% each year. "Its yield is high because it is a major player in gas, and that's a good story, longer-term," says David Gilmore, a portfolio manager at Federated Investors. Add that to the potential for 6% stock appreciation, and you've got a 12% overall return.
If you're still bent on buying growth stocks, dividends can offer a signpost to bargains. So-called "fallen-angel growth stocks" are former high-fliers whose dividend yields are unusually high simply because their share price has fallen. "By the time their dividend yields are 25% higher than the market's [dividend yield], the bad news has already been priced into the stock," observes Nancy Tengler, CEO of San Francisco-based Fremont Funds. So the shares are likely to go up, and you will be getting paid to watch them rise.
Several examples of fallen angels can be found among the major drug companies. During 2001, Bristol-Myers Squibb Co. (BMY ) and Merck & Co. (MRK ) saw their stock prices drop 32% and 38%, respectively, and both stocks yield around 2%. If you believe analysts' growth projections, both stocks could be up by about 8% in the next year. You would collect 2% in cash while you're waiting.
Of course, buying stocks purely on dividend yield is not smart. "Companies like AT&T (T ), Motorola (MOT ), and Nortel (NT ) became high-yielding stocks just before they cut their dividends," points out Thomas J. Huber, portfolio manager of the T. Rowe Price Dividend Growth Fund. The dividends are so high mainly because the companies have serious problems and the stock has been clobbered. And sometimes the market knocks down the troubled stocks when it expects a dividend cut.
Companies with a history of paying dividends are, at the very least, a sensible place to park your cash--and quite possibly a moneymaking opportunity in a market where few are in sight.
By Margaret Popper