Poor Mr. Dividend. Once a popular character at all the fashionable Wall Street gatherings, he slowly became an outcast. As the new millennium approached, many acquaintances seemed to be greeting him rather indifferently. Others, after decades of companionship, were less subtle, shunning him entirely. His old pals -- Mr. and Mrs. Investor -- suddenly wanted nothing to do with him and seemed to be spending a lot of time with a new friend, Mr. Stock Repurchase. Maybe it was for the best, he thought. After all, he was far too old to be cavorting with such a hip, young crowd.
It really wasn't fair for Mr. Dividend to be treated so callously by his former friends, the investors. Since 1926, he alone had accounted for nearly half (well, 42%) of their total returns. If only things could be as they were in the 1970s, Mr. Dividend waxed nostalgic. During that decade, the soirees seemed more toned-down, and he was able to give investors 80% of their total returns. By the 1990s, though, the parties were spinning out of control. During that wild time, he was only able to contribute a relative pittance of 10%. With his influence clearly waning, he wondered forlornly what had caused him to fall out of favor.
It all began when...
It is difficult to pinpoint exactly when dividends began to lose their status. A general downtrend had been in place for many years. The once-popular quarterly payments hit rock-bottom, after the market skyrocketed in the late 1990s. Many began to shy away from dividend-paying companies -- particularly in the tech sector -- believing all that cash could ultimately generate a larger return if judiciously plowed back into the company.
Who could possibly be interested in those inconsequential 2%-3% annual yields? Qualcomm
As the approach of Y2K began to make headlines, the yield on the popular S&P 500 benchmark dipped below 1.2% -- a far cry from the whopping 4.1% that the market had delivered on average in the postwar era. Even the Dow Jones Industrial Average, whose stalwart components comprised the titans of industry, saw its yield halved from 3.4% in 1990 to 1.6% in 1999. New companies entering the market also considered dividends passe, and by 1999 they were distributed by less than 4% of new publicly traded companies.
Aside from a public outcry for capital appreciation, there were other reasons for the decline: rising stock prices that pushed yields lower, smaller payout ratios as companies retained larger chunks of their earnings, and the rising popularity of stock repurchase programs as a more tax-efficient method of rewarding shareholders. Cynics might even point to the increased use of stock options as a form of compensation, as option holders generally do not profit from dividends.
The tide begins to turn
Things began to change in 2003, when new tax legislation was enacted, slashing the tax rate ceiling on dividends from as high as 39.6% (the top marginal tax bracket) to a more reasonable 15%. The move effectively ended the unfair practice of double taxation, and many companies immediately took notice. Citigroup
Within a year, more than 20 companies among the S&P 500 alone -- including International Gaming Technology
It can even be argued that the newfound interest in dividends carried the whole market higher. Fixed-income investments were near historic lows, and now income-seeking investors had added incentive to shift into equities. After being ravaged by a relentless bear market for three consecutive years, suddenly those reliable and now tax-advantaged cash payments of 2%-3% began to look inviting once more. The dividend tax cuts were passed in May 2003, and by year-end both the S&P and Nasdaq had climbed by more than 20%.
But what have you paid me lately?
If it seems like an abundance of companies have been raising their dividends lately, it's not just your imagination. Generally stronger corporate cash flows last year fueled the momentum generated by the tax cuts, which enabled many companies to loosen their purse strings even more. According to a New York Times article, the number of firms that cut or suspended dividend payments in 2004 dropped almost 40% to 64, the lowest number in over a decade. By contrast, the number of companies that decided to increase dividends jumped for the third consecutive year to a staggering 1,745.
Even though S&P companies collectively paid out $213.6 billion in dividends last year -- which would have shattered the old record even without Microsoft's
Not only do dividend-paying companies offer returns competitive with (and in many cases superior to) their non-paying counterparts, but they generally do so with far less volatility. Furthermore, there is a certain added attraction to cold, hard cash in hand. It can't be restated (cough, Krispy Kreme, cough), twisted, or manipulated like earnings. Not to mention that companies with the confidence to announce a dividend increase aren't terribly likely to have a cash flow shortfall lurking on the horizon. In fact, the very act of raising dividends has statistically been a reliable indicator of stronger earnings ahead.
That makes about 1,745 more reasons to anchor your portfolio with solid, dividend-paying stocks. Welcome back, Mr. Dividend. I believe we owe you an apology!
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Fool contributor Nathan Slaughter owns none of the companies mentioned. The Motley Fool is investors writing for investors.
