The Case for Dividends

No matter how young or old you are, no matter how daring or conservative your investment profile, you need dividend-paying stocks.

A bold statement, we know.

Can we back it up?
A slew of statistics support that claim, and there's research going back to the early 20th century, thanks to Professor Jeremy Siegel or Ibbotson Associates.

More recently, according to Standard & Poor's data, dividend-paying stocks have outperformed non-payers by a significant margin since 2000 -- $10,000 plunked down in dividend payers would've returned $18,443, while non-payers would've brought in just $13,015.

What's more, owning a healthy chunk of dividend payers would have spared you some of the heartburn caused by the stock market swoon of 2001 and 2002. Because in addition to outperforming their non-dividend-paying counterparts, payers also tend to be less volatile.

So why don't we all devote at least a portion of our portfolios to dividends? That's a good question.

The good news
More and more companies are paying dividends every year. Of the companies in the S&P 500 index, 388 paid a dividend in 2005 -- up from 351 in 2001 (and slightly up from the 372 in 2000). Since the start of this decade, even magical growth stocks Microsoft (Nasdaq: MSFT  ) and Qualcomm (Nasdaq: QCOM  ) began paying shareholders in cash.

That's big, because even stock buybacks can't always do what a dividend can. As was the case with many 1990s high-flying tech stocks, buybacks functioned merely to offset huge numbers of stock options. Moreover, money spent repurchasing overvalued stock is essentially wasted (at least in part). That's why large caps with hefty price-to-earnings ratios and enormous net cash positions such as Electronic Arts (Nasdaq: ERTS  ) , Google (Nasdaq: GOOG  ) , and eBay (Nasdaq: EBAY  ) should probably consider adding a dividend to their game plan. Or, at least, their shareholders should be agitating for it.

Because not only are more companies paying out dividends every year, they're also raising those payments every year. In 2004, 59% of dividend payers increased their payments year over year. Those ranks included Intel (Nasdaq: INTC  ) , which doubled its payment that year, and Goldman Sachs (NYSE: GS  ) , which ratcheted up its payout 35%.

Given the current 15% dividend tax rate, we view this return of capital to shareholders as a decidedly good thing.

Especially because of the inevitable market hiccup
With the years-long bull market in our rearview mirror, many investors are waiting for a slowdown. That may happen soon, or it may not. But it will happen eventually.

And how can you avoid years of zero gains in the market? You guessed it -- dividends. Because companies pay their dividends whether capital gains happen or not.

Excluding the 1990s, the lowest dividend contribution to the total return of the S&P 500 was 28.3%. So if you don't have dividend exposure in your portfolio, or an S&P tracker, you may in fact be facing down the prospect of zero gains in the near future. It's not too late, though.

Back to where we began
If you're in or nearing retirement, dividend stocks provide income and the hope of capital gains. If you're young and just constructing a portfolio, the power of reinvesting dividends can help you achieve your retirement goals.

But don't just take it from us. Andrew Carnegie, titan of capitalism and philanthropy, wrote this of his first dividend payment: "I shall remember that check as long as I live. ... It gave me the first penny of revenue from capital -- something that I had not worked for with the sweat of my brow. 'Eureka!' I cried. 'Here's the goose that lays the golden eggs.'"

Yet ...
Dividend payout ratios are less than half what they were 20 years ago. The S&P yield is currently around 1.7% -- not exactly the stuff of hair-tingling income production.

The average yield of our Motley Fool Income Investor recommendations, however, is a more robust 4.1%, and taken collectively, they're beating the S&P 500 benchmark by more than 9 percentage points.

To learn more about dividend investing, and to see our favorite dividend-paying stocks right now, click here for a free 30-day trial to Income Investor. There is no obligation to subscribe.

Brian Richards owns shares of Microsoft. Tim Hanson does not own shares of any company mentioned. Microsoft and Intel are Inside Value recommendations. Electronic Arts and eBay are Stock Advisor picks. Brian and Tim would like to pause 10 seconds for station identification. ... You're reading The Motley Fool. For the Fool's disclosure policy, go here.


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