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5 Facts You Didn't Know About Dividends

By Dan Caplinger – Updated Nov 30, 2016 at 8:03AM

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Many investors rely on income from their stock holdings. Learn what you need to know about dividend stocks.

Dividend stocks offer a perfect combination of growth potential and current income to investors. Many investors have emphasized dividend stocks in their portfolios in recent years, in part because of the lack of good income-producing alternatives and in part because of their strong performance. Yet there are some key facts about the dividend stock universe that many investors don't know about. Recently, the analysts at FactSet Research offered a look at the state of the dividend market, revealing some facts that most people don't know. Below, we'll share them with you along with some additional insight.

Image source: Getty Images.

1. Dividend payments have been on the rise

Total dividends paid among S&P 500 companies rose to their second-highest level in a decade during the second quarter of 2016, weighing in at $105.8 billion. That was slightly less than the amount companies paid during the first quarter of 2016, but it was up modestly from year-ago levels. Moreover, the $427.5 billion in dividends that S&P 500 components have paid over the past year is the highest on record and up more than 7% from where it was this time last year.

One of the biggest factors helping dividends has been the increased adoption of shareholder payouts among technology companies. For a long time, the tech sector paid almost no dividends, holding back the entire index as it became an increasingly influential part of the overall stock market. Now, however, two of the top three companies paying dividends are tech giants, and that has played a large role in dividend growth recently.

2. Dividends are more important than stock buybacks

Dividends are just one of two ways that most companies return capital to shareholders, with repurchasing shares being the alternative. Yet even as dividends have risen, gross share buybacks have fallen, weighing in at $230.9 billion during the second quarter and falling 3.5% compared to the year-ago period.

Investors should actually be happy that companies aren't spending as much on buybacks. After nearly eight years of stock market gains, many stocks have become extremely expensive, and all too often, buybacks prove to be ill-timed during times of business success. By paying dividends while cutting back on buybacks, companies can leave it up to investors whether they want to reinvest or use money in other ways.

3. For dividends, there were sector winners and losers

We've already called out the technology industry as paying strong dividends, but that wasn't the sector with the fastest growth. Those honors go to the telecom, healthcare, and financials sectors, all of which grew their dividends at double-digit percentage rates. By contrast, energy and materials saw year-over-year dividend declines.

None of those results is particularly surprising. The parts of the healthcare sector that typically pay dividends, including traditional pharma and health insurance stocks, have been successful and have shared their wealth by raising payouts. For health insurers in particular, low dividend yields give them plenty of room to boost dividends. Energy and materials have been hit hard by low commodities prices, and even though a rebound has started to emerge, companies will be slow in restoring dividends until they're absolutely certain that the tide has turned.

4. Payout ratios are getting high

Amid all this good news, there are a couple of warning signs for dividend investors. Payout ratios for the S&P 500 climbed to 39.5%, which is up from just over 25% five years ago and at its highest level since the 2008 recession, when depressed earnings skewed the measure. Also, 44 companies paid dividends that exceeded their earnings over the past 12 months, which is another factor that concerns dividend investors.

Few would be concerned about an individual stock with a 40% payout ratio, so it seems premature to worry too much about the overall market. However, some expect dividend growth to slow as a consequence of this, and if profits begin to contract, then companies will have to move aggressively to control their cash outflows if they don't want the overall payout ratio to rise more dramatically.

5. Dividend Aristocrats are doing better

Finally, some high-profile dividend payers are outperforming the market. Many investors look to the Dividend Aristocrats, which are stocks that have at least a 25-year record of consecutive dividend increases, as having the best dividend investments in the market. When FactSet made its report, performance through June had looked poor. However, since then, the Aristocrats have rebounded and are now outpacing the broader S&P 500 by nearly two percentage points over the past year.

Dividends can be a great source of income for investors. Just make sure you know the prevailing conditions for dividends in the stock market, and you'll be better able to navigate the changing climate and predict what the future will bring.

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