Dividends are the sensible shoes of investing. But, oddly enough, not everyone loves them, including superinvestor Warren Buffett, whose Berkshire Hathaway holding company has never paid a single one. Nor have dividends been universally applauded in academic works.
"If the dividend rate were as important as some investors consider it, the only research tool one would need would be a slide rule to determine the percentage yields of the various issues, and hence their 'value,' " Robert Edwards and John Magee wrote in their classic, Technical Analysis of Stock Trends, first published in 1948.
Dividends took a further hit during the tech boom of the late 1990s, when corporate executives concluded it was better to plow earnings back into their companies or use them for share buybacks than to pay them out to shareholders.
As it turned out, they were wrong. Investors went along for the ride because soaring share prices seemed to validate the strategy, until the spring of 2000 when the market collapsed.
Now, the worm has turned.
Investors feel burned by their losses. It seems wiser to take some of the company's earnings in dividends than trust in an uncertain future. Demographics play a role.
As the baby boomers age, they become more conservative and want to increase the portion of their portfolios devoted to interest income and dividends.
This shift has been reinforced by several recent studies that point to the superior performance of dividend-paying stocks. In "Surprise! Higher Dividends = High Earnings Growth" in the Financial Analysts Journal, Robert Arnott and Clifford Asness conclude that expected future earnings growth has been fastest when dividend payout ratios were high. A piece by Doron Nissim and Amir Ziv in The Journal of Finance shows that dividend increases are positively related to earnings changes in each of the two years after the dividend change.
It's a sad commentary on Corporate North America that money seems safer in the hands of investors than in the paws of executives, many of whom suffer from dreams of grandeur.
Some companies have clearly got the message. Bursting with $43-billion (U.S.) in cash, Microsoft announced in mid-January its first-ever dividend, albeit a very modest one. "We are especially pleased to be able to return profits to our shareholders, while maintaining our significant investment in research and development and satisfying our long-term capital requirements," the company explained in a release.
Already this year -- perhaps spurred by U.S. President George W. Bush's proposal to end the double taxation of dividends -- Citigroup, Wrigley, Newmont Mining and Lehman Brothers have boosted their dividends, and Qualcomm has announced its first dividend.
Buying high-quality common stocks with substantial dividends that increase on a regular basis is a sensible way to invest, particularly since the tax code favours dividends over interest income. But you can't do it by buying a major stock market index. Up until the early 1990s, the Dow Jones industrial average was thought to be in trouble if its yield fell below 3 per cent. How distant those days now seem. The yield is now 2.5 per cent, though that beats the Standard & Poor's 500-stock index (1.9 per cent), the S&P/TSX composite index (2 per cent) and the lowly Nasdaq Stock Market 100 (0.15 per cent).
But dividend-hungry investors do have options. Phillips, Hager & North's huge Dividend Income Fund has returned a stellar 13 per cent annually over 20 years. While new investors must put a minimum of $25,000 into a PH&N account, the fund has a modest 1.16-per-cent management expense ratio.
However, if an investor has a large enough portfolio to diversify properly, and doesn't mind taking the time to figure things out, he or she should be able to achieve a reasonable result by buying quality stocks directly. PH&N's top 10 holdings include the Big Five banks, Manulife Financial, BCE and Telus, hardly a tough portfolio to duplicate.
Merrill Lynch has composed a list of U.S. names that combine yield and quality, including BellSouth, Gillette, Hershey, Coca-Cola, 3M, Merck and Pfizer.
Tom Connolly of the Connolly Report of Kingston, Ont., has for many years provided a ranked list of high-yielding, generally high-quality Canadian stocks. Mr. Connolly is attracted to those that have long histories of uninterrupted dividend payments and frequent increases in payments. High on his list at the moment are problem-ridden TransAlta (yielding 6 per cent); Emera, the parent of Nova Scotia Power (5.7 per cent); TransCanada PipeLines (4.9 per cent) and Canadian Utilities (4.1 per cent).
Dividends may be dull, but anyone who has been an aggressive investor over the past few years knows that dull beats broke. Douglas Goold, a Toronto-based writer and broadcaster, can be reached at .