If
you can remember back to the 1950s, not only was Elvis cool, but so
were dividend-paying stocks. Investors bought them primarily for their
yield. But as the years dragged on, and capital appreciation took
center stage, they fell out of favor. They have regained some steam
since the Nasdaq bubble burst in 2000, and favorable tax treatment in
2003 encouraged investors to take a fresh look. Yet one mystery
remains: Given their strong performance track records, and other
benefits they provide, why are they not even more popular now?
The
numbers alone add up to a strong argument for seeking out dividend
payers. The Dow Jones Select Dividend Index, which tracks the 100
highest dividend-paying public stocks, has overtaken the S&P 500
for the past three-, five and 10-year periods. And in recent years,
several seminal studies have made measurable arguments for their
longer-term track records. Last year, Ned Davis Research published a
survey based on data from 1972 to 2005 that compared the results of
S&P stocks that paid dividends with those that did not. Its
remarkable findings demonstrated that over that entire period, dividend
payers gained a respectable 10.1 percent per year, while those that
shunned dividends rose a paltry 4.1 percent. Better yet, those that
increased their dividends posted gains of 10.6 percent.
In
their 2003 study, Clifford Asness and Robert Arnott discovered that
dividend size also helps to predict corporate profits: The higher the
dividend, the better the businesses performed over the subsequent 10
years. Their conclusions run counter to common wisdom, which might
suggest that companies fare better by plowing earnings back into
operations.
The meaning of dividends
Dividends
serve as a signaling tool from corporate managers—the people who are
assumed to have the best grasp of a company’s current operations and
potential. The dividend payers tend to be less cyclical and more
consistent in their operating results. The declaration of a dividend
payment indicates management’s confidence in the future, especially as
it realizes that it would send a dire message to the market to rescind
it down the road. So a handsome payout demonstrates a measure of the
company’s current and future health and cash flows.