These Dividends Still Have Room to Run

When it comes to investing, many skeptical investors believe that all good things must come to an end. For those who foresee an eventual crash for popular dividend stocks, though, it looks like the day of reckoning may take quite a while to arrive -- at least if the fundamentals behind many of those stocks have anything to do with their future performance.

Whenever you try to look at the subject of the latest investing craze, it can be difficult to separate out emotion from rational thought. That's why it's important not just to look at stock price movements of dividend stocks but also the key drivers that determine what their dividend payments may look like both in the near term and for years to come.

Another strong quarter for dividends
To get a sense of the overall dividend environment, I like to use the latest data about aggregate dividend behavior. S&P Dow Jones Indices provides a report every quarter that provides a nice summary of the health of dividends in the U.S. stock market.

The second quarter of 2012 continued a long trend of improvement among dividend-paying stocks. During the quarter, companies announced 505 dividend increases, compared to 441 during last year's second quarter and raising the six-month total for the year so far to its highest level since 2007. Meanwhile, with just 37 announced dividend cuts, the breadth of the overall market with respect to dividends continues to look extremely good.

All those dividend increases resulted in an additional $12 billion of dividend payments going to shareholders in the second quarter, which S&P Dow Jones Indices believes is enough to set a new record for total quarterly dividends paid by U.S. stocks.

Why there's room to run
The figures above may imply to some readers that dividends must be nearing a cyclical peak. But historical comparisons show that the long streak of below-average payout ratios continues for dividend stocks. The report said that even though yields rose from 2.58% to 2.77% during the quarter, payout rates remain near their lows, with an average of 31% compared to the longer-term historical figure above 50%. The conclusion the report draws is that further gains in dividend payments should continue for the rest of the year.

Moreover, you can find many stocks that not only have high yields and low payout ratios but also reasonable valuations based on earnings as well. According to S&P Capital IQ, resources stocks Freeport-McMoRan Copper & Gold (NYSE: FCX  ) , Chevron (NYSE: CVX  ) , and Cliffs Natural Resources (NYSE: CLF  ) have earnings multiples in the single digits and yields well above the 3% mark, but neither pays out more than a quarter of its earnings. Nor are the opportunities restricted to that sector; hard-drive maker Seagate Technology (Nasdaq: STX  ) and niche insurance provider Aflac (NYSE: AFL  ) meet the same criteria.

A taxing proposal
However, dividends do have some uncertainty. The current preferential tax rate on qualified dividend distributions will end at the beginning of 2013 unless new tax laws extend it. With the report citing savings of $358 billion during the 10-year span of the dividend tax cut, a reversal of the rate reduction would likely make companies substitute more buybacks for dividend payments, cutting payout ratios still further.

Nevertheless, given the number of investors who hold dividend stocks in retirement accounts, and therefore don't worry about taxes in any event, a collapse in dividend stocks due to tax changes isn't imminent. Moreover, there's always the possibility that new tax provisions will be in place in time to forestall the huge rate increase.

Keep taking the money
As with all your stocks, you have to look closely at the dividend stocks in your portfolio to make sure that their valuations are consistent with your view of their intrinsic value. But with many reasonably priced dividend stocks still available, the death of dividend investing doesn't look likely anytime soon.

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Fool contributor Dan Caplinger has his share of dividend stocks. He doesn't own shares of the companies mentioned in this article. You can follow him on Twitter @DanCaplinger. The Motley Fool owns shares of Freeport-McMoRan. Motley Fool newsletter services have recommended buying shares of Aflac and Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy pays off for you.


Read/Post Comments (10) | Recommend This Article (44)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 19, 2012, at 12:19 PM, Fool wrote:

    Dan -

    Is a significant reason that payout ratios are so low because companies have been slashing their costs in recent years as a short-term way to boost earnings?

    If the economy continues to drag and topline growth is constrained -- is it possible we might see those payout ratios shoot back up and endanger the previously 'safe' dividend payouts?

  • Report this Comment On July 19, 2012, at 4:17 PM, TMFGalagan wrote:

    @TXinvestor82 - It depends. If you think cost cuts were temporary and that companies will eventually have to boost expenses even in a flat revenue environment, then yes, earnings could take a hit. But if you think earnings will plateau rather than fall, then payout ratios may simply rise modestly along with dividend payouts.

    best,

    dan (TMF Galagan)

  • Report this Comment On July 19, 2012, at 8:50 PM, maiday2000 wrote:

    "Nevertheless, given the number of investors who hold dividend stocks in retirement accounts, and therefore don't worry about taxes in any event, a collapse in dividend stocks due to tax changes isn't imminent."

    That is, until a cash-strapped Federal Government sees the trillions of dollars in tax-advantaged retirement accounts and wants a piece of the pie for themselves. Don't think they aren't considering it...

  • Report this Comment On July 19, 2012, at 10:29 PM, crudeoiltrader wrote:

    Bring on the tax increase on dividends. We'll just focus on our Roth IRA's for now. What's that gonna do for the economy?

  • Report this Comment On July 19, 2012, at 10:48 PM, xetn wrote:

    Taxes do nothing for the economy, they take resources out of the economy and make every thing more expensive. Consider, if there were no taxes, how much more would you have in spendable (discretionary) income?

  • Report this Comment On July 20, 2012, at 4:38 AM, MrSheepish wrote:

    "Taxes do nothing for the economy, they take resources out of the economy and make every thing more expensive. Consider, if there were no taxes, how much more would you have in spendable (discretionary) income?"

    No taxes at all, huh? That sounds like a good idea. I think I would enjoy a world like that ... well ... except for when the roads fall apart, the schools fail, the rivers become polluted and catch fire (again) burning down the cities which no longer have fire departments, the riots and looting spread unchecked, and the hostile countries invade. Other that those minor things I think I would be happier. :)

  • Report this Comment On July 20, 2012, at 4:49 PM, EDJMCPS wrote:

    The real question is why the Government does not set up a real budget and pass it. Taxes could be a lot lower if there were budget controlls and money spent were it was really needed. In the last 60 Years congress has only passed 4 (FOUR) budgets.

    All the talk about budgets is smoke, all the money spent on budgets, all the books on budgets printed in the millions of dollars and none but 4 budgets were passed in the last 60 years. Tells you how serious congress is with out tax money and the national debt. Money is no object for the Government after all they have an open ended check book, with you & me and our kids all footing the bill.

    Right now the National Debt is $68,000.00 per person (every man-women and child). Do you have your $68,000.00 set aside for when they come calling? ($272,000.00 for a Family of four)

  • Report this Comment On July 20, 2012, at 6:40 PM, PoundMutt wrote:

    If Obama is reelected with a Democrat congress I think you can kiss your ROTH IRAs goodbye!

  • Report this Comment On July 22, 2012, at 1:33 PM, lowmaple wrote:

    maiday: Right on, just look at the Canadian Conservative Government few years back change dules for oil reits so they could get more taxes. Payouts have dropped by 30-40% or more. And the stocks involved by 40%. Any retiries lost big time there. BTW not just foreigners but Canadians also lost out. Unlike what many in the MF response comments thought at the time.

  • Report this Comment On August 03, 2012, at 1:21 PM, thidmark wrote:

    I could see the government grandfathering out the IRA, but there is no way in hell it is hijacking current IRAs -- unless it is courting a bloody revolution.

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