The Delights of Dividend Stocks

They're doing well in the current market, fall more slowly if things turn bearish, and some beat money-market returns. What's not to like?

By Amey Stone

How do I love dividends? Let me count the ways. I love thee like a...

Tempting as it is to continue in the style of Elizabeth Barrett Browning's famous poem, it's just as easy to state the case plainly: This is a great time to add some dividend stocks to your portfolio.

On Feb. 17, Coca-Cola (KO ) announced a 12% increase in its quarterly dividend, to 28 cents per share, or the equivalent of about a 2.6% annual dividend yield. Coca-Cola isn't alone.

According to a study by Standard & Poor's, 2005 should be a record year for increases in both the number of companies increasing their dividend amounts and in total dollars paid out. S&P expects companies in the S&P 500-stock index to distribute a total of $21.80 per share, or $203 billion, a 12% increase over $181 billion paid out in 2004. That's some serious loot.

Here are four reasons why you, too, should love dividend stocks:

• They're outperforming. S&P's data shows that through Feb. 14, dividend payers have averaged a 0.6% increase in stock price this year, in contrast to a loss of 5.01% for those not paying dividends. In 2004, payers returned 18.35%, vs. 13.65% for nonpayers. S&P equity market analyst Howard Silverblatt believes this could be just the start of a long cycle during which stocks with dividends outperform those without.

• They're less volatile. That's because, since the companies pay out cash, investors are more willing to hold dividend stocks through bear markets. Hence, they don't fall as far as quickly as nondividend stocks. They also tend not to rise as fast as nondividend stocks during roaring bull markets. But many investors burned in the long bear market and now worried about slowing economic growth are looking for downside protection.

• They get favorable tax treatment. Thanks to a change in tax law in May, 2003, most dividend payments are taxed at a 15% rate instead of as ordinary income. That means investors may get more current income from a high-yielding stock than they would in a certificate of deposit or money market (although stocks carry substantially more risk).

The tax change has generated savings for individuals so far totaling $30 billion, says Silverblatt. Through 2008, when the tax break is set to expire -- although it may well be extended longer -- the savings to investors will exceed $100 billion, Silverblatt figures.

• By reinvesting dividends, you "dollar-cost average" without even realizing it. Dollar-cost averaging -- investing a set amount at specific intervals so that you buy more shares when the price is low and fewer shares when the price is high -- is an excellent way to lower volatility and improve your portfolio's long-term returns. Wharton professor Jeremy Siegel sees this dynamic as one of the main reasons why dividend-paying stocks outperform nondividend ones over the long term -- a key tenet in his upcoming book, The Future For Investors.

Hunting for dividend stocks? BusinessWeek's Robert Barker wrote a column recently highlighting high-dividend stocks, such as Bank of America (BAC ), ConAgra Foods (CAG ), and Merck (MRK ) (see BW Online, 2/7/05, "Still Sweet on Dividend Stocks").

And S&P maintains a list of what it calls "Dividend Aristocrats" at (select S&P 500 Dividends from the box listing Index Highlights). These 58 S&P 500 companies have increased their dividend payments in each of the last 25 years. They include companies hiking their dividends in 2005, like 3M (MMM ), Comerica (CMA ), and May Department Stores (MAY ). The list is worth a look -- this year more than ever.

Amey Stone is a senior writer at BusinessWeek Online

Edited by Phil Mintz

Before it's here, it's on the Bloomberg Terminal.