Dividends in the Spotlight

Larger cash payments will depend on how companies and investors react to the new tax law

By Joseph Lisanti

Now that dividends are taxed at the same rate as capital gains, will investors start seeing higher payouts? That's difficult to say, but many companies certainly have the ability to boost their dividends.

Since the end of World War II, the payout ratio of the S&P 500 has averaged 51%, based on reported earnings. In other words, more than half the index's earnings were paid in the form of dividends.

Based on our estimates of the earnings companies will report and the dividends they will pay, we believe that the payout ratio on the "500" will only be 38.5% this year. That's 25% below the historical average.

Some investors believe that a payout ratio based on reported earnings is the wrong yardstick. Under U.S. generally accepted accounting principles, certain non-cash charges can reduce reported earnings, thus boosting the payout ratio. But even based on operating earnings, we estimate that the S&P 500's payout ratio this year will be only 30.5%, or 27% below the average from 1988 through 2002. We do not have operating earnings data for the index before 1988.

Barring a mass conversion of top corporate executives to the dividend persuasion, we see distributions on the S&P 500 totaling 16.42 this year, up only 2.1% from 2002. That's less than half the 5.6% compound annual growth rate of S&P 500 dividends since 1945.

As long as corporations can claim that the tax changes are temporary -- they are set to expire in 2008 -- some will resist changing their dividend policies. But we suspect that many investors, mauled by the most vicious bear market in memory, will pressure companies to provide a more certain return than hoped-for capital gains. And even if tax rates rise in future years, we believe it is likely that dividends and capital gains will continue to be taxed equally.

For now, maintain 65% of investment assets in stocks.

Lisanti is editor of Standard & Poor's weekly investing newsletter, The Outlook

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