Do Dividends Matter?
09/10/2004 12:00 am EST
"Have the prices of dividend-paying stocks benefited from the decrease in the tax on dividends?" asks mutual fund expert Sheldon Jacobs. Here, he offers an insightful look at dividend-paying equity funds, as well as his top ideas within this arena.
"In May 2003, Congress cut the tax on dividends from the ordinary income rate to a maximum of 15%. That put most dividends on a par with the capital gains tax, which also was cut to a maximum of 15%. It is indisputable that after cutting dividends from 1999 to 2001, corporations have been increasing their payouts. Through July 31, 2004, 170 companies in the S&P 500 have increased their dividends this year, while 10 companies in the index have instituted dividends for the first time. Even Microsoft, which formerly hoarded cash or invested in it other businesses, has decided to pay a large special dividend while tripling its quarterly payout.
"We investigated this matter in terms of our mutual fund database. On a total return basis, funds paying out dividends have done fine over the past 12 months, but we can’t say they have gone wild. Diversified funds yielding 2% or more haven’t posted significantly greater total returns than lower-yielding peers. Over the past 12 months, funds with yields above 2% showed a total return of 21.2% while funds with no yield returned 24.7%. But in the last three years of the 1990s bull market, funds with no dividend payouts had far superior gains than did funds with dividends while during the 2000 to 2002 bear market period, based on annualized return, funds with no yield lost 12.7% while funds yielding 2%+ lost just 4.4%
"Where does this leave fund investors? By and large, dividend-paying funds are less risky than funds that pay no dividends. Diversified funds with dividends of 1% or more have an average beta of .85, while funds that don’t pay dividends have an average beta of 1.00. This means dividend paying funds are likely to fall less than the market when it falls, while funds with no dividends are likely to fall more than the market. It seems to us that if dividend-paying funds are doing as well as non-dividend-paying funds this year, investors can decrease their risk by including some dividend-paying funds in their portfolios.
"One dividend-paying fund we recommend is Alpine Dynamic Dividend (ADVDX ), which was started in direct response to the dividend tax cut. The fund is on track to yield more than 6% this year. Every stock in the fund pays a dividend and manager Jill Evans, hopes to provide a yield of at least 4% annually going forward. She invests in three types of stocks: mature; growth & income; and turnarounds. The mature category includes the stock of companies that return cash to shareholders as opposed to pursing faster growth. Evans’ growth & income stocks tend to provide moderate levels of dividends and turnarounds are dividend-paying companies whose stocks have fallen but that may benefit from a catalyst. Industrial and machinery stocks, as well as other areas of the market that tend to include many dividend-paying companies – such as financial services and healthcare – have strong exposure in the fund. Evans also recognizes that most of the funds’ shareholders are likely to be low-risk investors, so she’s careful to limit the amount she puts in any one stock and to buy her stocks at reasonable or low prices.
"Another diversified stock fund we recommend that pays relatively high dividends is T. Rowe Price Equity Income (PRFDX ), managed by Brian Rogers since its 1985 inception. Rogers views dividends in two ways; one, as a desirable end in and of themselves, and two, as a means to finding attractively valued companies. The fund’s yield in any one year has been about 1.5 times that of the S&P 500. Rogers seeks out the stocks of companies that appear cheap relative to their own histories and the market. Relative dividend yield, which measures a company’s yield in comparison to that of the market, is often Roger’s most important valuation tool. He gravitates toward big companies with staying power, and the fund tends to go where the yield happens to be: areas such as financial services, industrials, energy, healthcare, and telecommunications services. The fund produced gains in 2000 and 2001 (while the market tanked) and a much-less-than-average loss in 2002. It’s a conservative fund, run by an experienced manager, with a proven investment approach."