The Value of Dividends

01/15/2012 10:45 am EST

Focus: INCOME

John Buckingham

Editor, The Prudent Speculator

With interest rates at rock-bottom levels, investor attention has turned back toward dividend-paying stocks. And for good reason, as high-yielding equity strategies such as 'Dogs of the Dow' performed very well in 2011.

It turns out that dividend-paying stocks give you an edge in the long run, too. Using data from economists Eugene Fama and Kenneth French, who reached all the way back to 1927 to find historical returns, we calculated that the annualized return for non-dividend-­paying stocks through July 30, 2011 was 8.4%, compared with 8.9% for the group of stocks with the lowest dividend payouts, 10.2% for the next highest group and 11.1% for the group with the highest dividends.

I had my own research team run the numbers on the broad-based Russell 3000 Index over a period of the past 20 years. Dividend stocks outperformed their counterparts on both an equal-weighted (11% per annum for dividend payers versus 8.5% for nondividend stocks) and a capitalization-weighted (8.5% versus 7.8%) basis. I would even argue that returns of dividend stocks have been far less volatile in the same time frame.

Okay, it's no secret that I like dividend stocks. But value investing is my firm's specialty, and I especially like yield stocks that have attractive fundamentals-low price/earnings multiples and low price-to-book-value ratios. Keep in mind that the yield on the broad-based Russell 3000 index is approximately 2.0%, while the Russell 3000 Value component of that index was recently sporting a dividend yield of 2.6%.

Compare that with returns from cash and US ­Treasurys. Money market funds are the modern-day equivalents of the mattress, paying a miserly 0.02% on average. At that rate your money will double in 3,466 years. Meanwhile, supposedly risk-free US Treasurys appear to be offering ­negative real returns. Considering that inflation has averaged 3% per annum over the past eight decades, a 2% yield on the ten-year Treasury is thus a loser's game.

It must be a sign of the times when return of principal is seemingly more ­important to investors than return on principal. Corporations are flush with cash and have been boosting their dividend payouts, with nearly two-thirds of the S&P 500 members either raising or initiating a dividend in 2011. Operating earnings per share on the S&P 500 should jump from $84 in 2010 to $97 this year and $107 in 2012. It's hard to imagine companies not boosting their payouts alongside earnings.

Here are some places where I'm finding good yields with great value: Commodities giant Freeport McMoran Copper & Gold (FCX), which with special dividends included yields over 5%, giant utility company Exelon (EXC), which boasts a payout of nearly 5%, and technology titan, which sports a dividend of 3.5%.

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