Dividends: Now More Than Ever

I'm usually not much for pundits who proclaim with Carnac-like certainty the direction of the stock market. But I do pay attention to economists. I do so because the health of the overall market -- and, arguably, my portfolio -- is indelibly linked to the amount of moola consumers sock away for a better tomorrow. No one knows better what we as a nation do and don't have than those who study the numbers daily. That's why I fear a day of reckoning is coming.

The bubble babble
I've seen economists become much more bearish lately. Over the summer, the head honcho of 'em all, outgoing Federal Reserve Chairman Alan Greenspan, was like rain at a parade. In comments made at a meeting of the Fed in Jackson Hole, Wyo., Greenspan had some choice words for investors, especially those running roughshod over their home's equity:

This vast increase in the market value of asset claims [read: real estate] is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent. To some extent, those higher values may be reflecting the increased flexibility and resilience of our economy. But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low-risk premiums.

I'm not an economist, so I won't even attempt to translate. Instead, I'll turn to John Mauldin, an investment advisor and author of an interesting new book called Just One Thing, from whose weekly newsletter I pulled this gem. Mauldin argues that Greenspan believes we ought to reduce our risk -- and do it now, before housing prices start to fall.

No crystal ball, but maybe a case of deja vu?
That's not to say that Greenspan, Mauldin, or any of us possesses even the slightest degree of clairvoyance. No one knows when today's fragile conditions will turn to a recession and a bear market, if ever. But when 80% of gross domestic product is tied to increases in U.S. household debt -- as reported by portfolio manager Steven Dray of Babson Capital Management in a recent issue of Better Investing -- it seems appropriate to say we're drunk with spending, and that last call is coming.

Or maybe we ought to just say we've been here before, at the end of the last millennium. Bubble or no, we're spending way more than we're saving. Indeed, the national savings rate has dropped from an average of 4.5% in 1987 to just 1% today. And this in a market that's still plagued by high oil prices and which, not long ago, saw the yield curve invert for the first time since the last recession.

Neither is a sign of impending apocalypse, of course. (Check out Bill Mann's recent commentary for more.) But you'd have to be on a Prozac high to not be at least a little wary. And I've skinned my knees with poor stock picks enough times to know that fortune favors the prepared.

Sometimes the best defense is ... a good defense
History shows that there are few better ways to muddle through a declining or flat market than with dividend-paying stocks. That's because dividend-payers tend to keep their payouts in both bull and bear markets. And the best increase their payouts regardless. The regular delivery of checks can add needed ballast to a leaky portfolio during bad times.

In fact, I've got personal experience in this area. During the last bubble, I had invested my wife's portfolio in a few dividend-payers such as International Paper (NYSE: IP  ) and SBC Communications (now AT&T (NYSE: T  ) ). My guess was that these stocks would prove safe, and that the moola would add a nice cushion. That wasn't just arm-waving; at the time, both stocks were producing ample levels of free cash flow, had a record of boosting their dividends, and paid out just a fraction of earnings to shareholders.

Meanwhile, I took a little more risk with high-fliers such as American Power Conversion (Nasdaq: APCC  ) and Sun Microsystems (Nasdaq: SUNW  ) in my portfolio. Friends and family followed in my footsteps, plopping down moola for risky tech bets on CMGI (Nasdaq: CMGI  ) , Yahoo! (Nasdaq: YHOO  ) , and the former AOL Time Warner (NYSE: TWX  ) . Having been around tech for nearly 15 years, I thought I had a firm grasp of the risks. My hubris cost us dearly. But my wife's portfolio lost nothing. The dividends spared her a loss of capital.

Guarantee your returns
It makes sense, doesn't it? Not to oversimplify things, but if you had $10,000 to invest, and you bought 1,000 shares of ACME Rocket (Ticker: BOOM) at $10 a share with a 5% dividend, you'd do well in a flat market. In fact, if the shares didn't move an inch for five years, your total return would be 25% if you did nothing but collect the cash. If you reinvested the proceeds, your return would be nearly 28%.

That's why dividend-paying stocks are worth your time. And we've got just the Fool to help you. Mathew Emmert is chief analyst for Motley Fool Income Investor. Over the past two years, his picks have beaten the market by more than 4% and paid an average annual yield of 4.58%, all while taking on much lower risk. (If that sounds appealing, you're welcome to try the service free for 30 days.)

Are stocks heading lower soon? It sure seems like it. But even if not, I still think it's fair to say that we're investing in a market that's largely built on the assumption that we'll grow our assets and income well into the foreseeable future. In such an environment, there can be few guarantees. Dividends -- the promise of cold, hard cash -- may be the best of them all.

This article was originally published on Sept. 9, 2005. It has been updated.

Fool contributorTim Beyersloves getting paid to invest. He didn't own shares in any companies mentioned in this story at the time of publication. You can find out what's in his portfolio by checking his Foolprofile. Time Warner is a Motley Fool Stock Advisor recommendation. The Motley Fool has an ironcladdisclosure policy.


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