Dividends Are Back

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Dividends are back.

Well, they never really went away, but now they appear to be enjoying a surge in popularity, partly because they’re rising and partly because investors are hungrily searching for an alternative to low fixed-income yields.

Dividends are a portion of company profits paid out to shareholders, and healthy companies try to raise the payouts from time to time. But the financial crisis took a toll. In 2009, just 157 companies in the Standard & Poor’s 500 raised dividends, while 78 cut them, according to The Wall Street Journal. But 105 had raised dividends this year, through April, and just two cut them.

Currently, dividends are taxed at a maximum rate of 15%, while interest can be taxed as high as 35%, making dividends especially appealing. But the future is uncertain, as Washington must decide what to do when the Bush tax cuts expire at the end of this year. Taxes on dividends could well go up.

In the short run, dividends from the S&P 500 won’t make anyone rich. You’d get only about $1.80 for every $100 invested. (Dividend yield is annual dividends divided by a stock’s current price.)

In the long term, dividends can add a lot to investment results. An analysis by T. Rowe Price (Stock Quote: TROW) found that dividends accounted for about 44% of gains enjoyed by S&P 500 investors since 1925. That assumes all dividends were reinvested. Over time, more and more of one’s S&P 500 stocks would be traced to reinvested dividends, and those stocks would pay dividends used to buy additional shares. It’s the snowballing that causes that 44% figure.

Long-term performance figures always assume that all dividends are reinvested. If you take the dividends as income, your stock’s performance will suffer.

Many retirees, of course, do depend on dividends to supplement income, and many investors feel dividend-paying companies tend to be safer bets than non-payers. Dividend stocks generally do better than non-payers in weak markets, but trail in rebounds. When the stock market soared in 2009, dividend payers in the S&P 500 gained only 26%, non-payers 65%, according to T. Rowe Price.

Today, it’s not hard to find some dividend-paying stocks yielding upwards of 5%, which is pretty good compared to the paltry yields on fixed-income investments. Five-year certificates of deposit yield an average of just 2.1%, according to the BankingMyWay.com survey.

There’s a big difference, of course: CDs carry federal insurance against loss, while stocks can fall in value.

Also, beware stocks paying dividends that are too big to believe, such as 10% or more. Often, that’s because the stock’s price has fallen, and a dividend cut may follow.

A good place look for solid dividend payers is among the Dividend Aristocrats, a list compiled by Standard & Poor’s of companies that have raised dividends every year for 25 years.

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