New Taxes Can't Stop These Dividends

Right now, most of us pay a 15% tax on our dividends. Next year, alas, we'll probably pay 20%. But don't assume the increase will make dividends any less attractive. That 20% tax won't hurt as much as you think.

The taxing haircut
Don't believe in the power of dividends? Consider that between 1926 and 2006, 41% of the S&P 500's total return came not from the price appreciation of the stocks, but from the dividends they paid out.

Below, I've rounded up several stocks that sport four or five (out of five) stars in our CAPS community of investors, plus dividend yields of 5% or more. If you have to forfeit 20% of your dividend gain to Uncle Sam, you'll see that you're still effectively left with a rather attractive yield:

Company

Dividend Yield

Yield Less 20%

CenturyLink (NYSE: CTL  )

8.2%

6.6%

Altria (NYSE: MO  )

6.4%

5.1%

Frontline (NYSE: FRO  )

9.1%

7.3%

Apollo Investment (Nasdaq: AINV  )

11.1%

8.9%

Exelon (NYSE: EXC  )

5%

4%

Duke Energy (NYSE: DUK  )

5.7%

4.6%

Data: Yahoo! Finance.

These companies offer more than just dividends -- although several also sport red flags:

  • CenturyLink is a growing rural telecom provider, though its steep payout ratio of 99% makes me worry about the sustainability of its dividend. Its impending merger with Qwest could change that picture somewhat.
  • Altria sells a literally addictive product, and it's been able to increase its market share in the U.S.
  • Oil-tanker specialist Frontline has been an incredible dividend payer in the past, but it's also carrying a lot of debt.
  • Mezzanine capital provider Apollo Investment has an inconsistent dividend history.
  • Duke Energy offers diversification between electricity and gas, but it's been struggling lately.
  • Nuclear power giant Exelon may be the most exciting in the bunch, with fat profit margins and robust earnings growth.

If I were interested in buying any of those companies, I wouldn't let a tax hike deter me. The same holds true even for lesser dividends. Here are a few big-name blue chips with four- or five-star ratings and yields topping 3%:

Company

Dividend Yield

Yield Less 20%

Pfizer (NYSE: PFE  )

4.9%

3.9%

Kimberly-Clark

4.2%

3.4%

Waste Management

3.8%

3%

Data: Yahoo! Finance.

Dividends rule
It's hard to make dividends less attractive, even if they're taxed at your full ordinary income rate -- as was the case not so long ago. Reliability is one of dividends' best qualities. If they come from a healthy and growing company, you can pretty much count on getting those payouts, whatever the economic environment. Even when the stock price slumps or stalls, you'll get your chunk of change.

Better still, healthy dividend payers increase their payouts over time. Kimberly-Clark, Waste Management, CenturyLink, and Exelon have hiked theirs by an annual average of 8% or more over the past five years. That's a great way to build your income over time while staying ahead of inflation. Pfizer slashed its dividend sharply in 2009, and it's since suffered from underwhelming drug trials and FDA wrangling. But the strength of a promising pipeline stuffed with several hundred drug candidates is already helping the company to rebuild its payout.

Whether the tax rate is 15%, 20%, or even more, it's hard to beat dividends. Don't let a tax bite scare you away from their potential power to pile up profits.

Learn how to find the most promising dividend payers.

Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. Exelon, Pfizer, and Waste Management are Motley Fool Inside Value selections. Duke Energy, Kimberly Clark, and Waste Management are Motley Fool Income Investor picks. Motley Fool Options has recommended writing puts on Exelon. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.


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  • Report this Comment On July 28, 2010, at 7:57 AM, WmHilger1 wrote:

    You might want to re-check your numbers. FRO shows only a 4.2% dividend on the Investor page of this site.

  • Report this Comment On July 28, 2010, at 8:49 AM, OSUMAG wrote:

    Selena,

    Excellent points. I have one clarification [I could not answer yesterday as I read these blogs on my Amazon Kindle]. Barring any Congressional action, next year, the dividend tax rate will be taxed at ordinary tax rates, which can be as high as 39.6%. Of course, the Obama administration would like to keep the dividend rates low for those making less than $250K/year. Geithner has come out saying he would like the tax cuts to expire for the wealthy.

    http://www.cnbc.com/id/38414912

    You may have also seen Geithner's comments a few weeks ago to limit the dividend and capital gains rate to 20%, so there is some discrepancy in his statements.

    http://www.cnbc.com/id/38231142

    On one day, he wants the tax cuts for the wealthy to expire, but on another day, he wants to cap the dividend and capital gains tax at 20%. Maybe, he wants the both (tax wages/income up to 39.6%, but place limits on dividends and capital gains), but I have not seen or heard any of the details yet. We still need Congress to do something before any of these proposals come to fruition.

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