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Rising stock dividends regain allure as investment strategy

With millions of people looking for investment income amid dismally low interest rates on bank accounts and bonds, Wall Street believes there's a huge audience for the dividend story.

February 26, 2012|By Tom Petruno
(Skip Sterling / For The Times )

Trying to overcome Americans' deep distrust of the stock market, Wall Street has latched on to an investing concept from a bygone era: Buy equities and get cash back every quarter, potentially for as long as you own the shares.

The come-on is for the dividends that many companies have regularly paid to their shareholders. For much of the last century, dividends were the primary reason to own stocks. The chance of capital appreciation was secondary.

As share prices rocketed in the wild bull market of the 1980s and 1990s, dividends became an afterthought.

No more. With tens of millions of people — particularly retiring baby boomers — looking for investment income and fed up with dismally low interest rates on bank accounts and bonds, brokerages and money managers believe there's a huge and growing audience for the dividend pitch.

Investment strategists at major firms such as BlackRock Inc., Pimco and Wells Fargo Securities have been tripping over one another to highlight dividends' appeal for the last year. Newport Beach-based Pimco, best known for its bond portfolios, in December launched two dividend-focused stock mutual funds.

Big-name companies including Amgen Inc., Starbucks Corp., Walt Disney Co. and Microsoft Corp. also helped stoke investors' interest in 2011. Each raised their cash payouts to shareholders by 25% or more.

The dividend story could soon get another big boost: Apple Inc., which has long hoarded the cash generated by its phenomenally successful products, is under pressure to spread some of that wealth by reinstating a payout. The company hasn't paid a dividend since 1995.

Apple management is thinking "very deeply" about what to do with the firm's $100 billion in cash, Chief Executive Tim Cook told shareholders at the annual meeting last week.

Flush with earnings from the recovering economy, big-name companies in the Standard & Poor's 500 index are expected to pay total dividends of $263 billion this year, up 9.1% from 2011 and surpassing the previous record of $248 billion in 2008, said Howard Silverblatt, senior index analyst at S&P in New York.

Some veteran small investors don't need convincing about dividends' allure. Jim Peoples, a 67-year-old retiree in Agoura Hills, says he has become more conscious of the benefits of those cash payments over the last decade, as bond and bank-account interest rates have plummeted.

His portfolio includes stocks such as AT&T Corp., Philip Morris International Inc. and Caterpillar Inc., all three of which have histories of regular dividend increases.

Five years ago, 300 shares of Caterpillar paid annual dividends of $360. Now those same shares pay dividends of $552, a 53% increase.

That's a big advantage over the bonds in his portfolio, Peoples says, because bond interest payments stay the same for the life of the security.

If investors are relying solely on fixed-rate bonds, he says, "You're not going to have purchasing power. The spending value of that money is really going to go down" after inflation.

What's more, at least for now dividends get a tax break. They are federally taxed at a maximum rate of 15%. Bond and bank interest is taxed at ordinary rates, up to 35%.

Still, Wall Street knows it has an uphill battle persuading many investors to come back to stocks after two devastating market crashes in the last decade.

With current annual dividend payments on many blue-chip stocks equivalent to a "yield" of 2% to 4% on the price of the shares, that's attractive compared with interest on bonds and bank savings. A 10-year U.S. Treasury note pays an annual yield of just 1.98%.

But shareholders always face the risk of a stock losing value. In another market downdraft it would be easy for a drop in a company's share price to totally offset annual dividend earnings in a matter of minutes.

By definition, investing for dividend income requires a buy-and-hold strategy — exactly the approach that became discredited in the last decade as much of the stock market has flat-lined.

To get the full benefit of rising dividends, "You have to truly make a long-term commitment of capital" to stocks, said Josh Peters, dividend strategist at investment research firm Morningstar Inc. in Chicago.

That's a tough sell for plenty of skittish investors, and for their advisors.

Eric Bruck, a principal at financial advisory firm Silver Oak Wealth Advisors in Los Angeles, has favored the relative safety of bonds for his clients since the 2008-09 stock market plunge.

Yet as market interest rates have fallen, "We have to use a fine-tooth comb to find bonds we want to buy today," Bruck said.

In the last few months the firm has moved a small portion of the average client's portfolio into dividend-paying blue-chip stocks, such as Johnson & Johnson and Colgate-Palmolive Co., via mutual funds that focus on those issues, Bruck said.

But he said he couldn't imagine shifting most clients' assets heavily toward stocks because of the risk of another episode of severe volatility.

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