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Markets: Divine Dividends
New York: May 28, 2007
By John R. Stephenson

What is old is new again. Yes, the dividend-paying corporation is all the rage on Wall Street once more. Investors, fed-up with the empty promises of growth stocks, such as technology companies, are turning increasingly to more traditional, slower growing companies that promise steady income in the form of dividends. Think dividends are something for your parents' generation? Think again! Research analysts have determined (based on stock market dating from 1926) that dividends have accounted for at least 35 % of a stock's total return (price appreciation plus dividends). Add in the impact of dividend reinvestment and the returns from dividend paying stocks become truly staggering.

Everyone is getting into the act, including technology giant Microsoft, which a few years ago took the plunge and declared a special dividend. But the true beauty of dividends lies in the fact that dividends are declared promises to pay a certain amount each and every year by a company's board of directors. A stock that doesn't carry a dividend offers no such promises. Not only that, but the price of all stocks change daily based on what investors think the company's cash flows might be in the future. Because investors are fickle, stock prices are volatile and tend to gyrate widely in the short-term. Dividends aren't based on the perceptions of investors, but rather, they are based on the actual operations and available cash of a given firm.

But why don't all companies pay a dividend? For starters, younger, less mature companies typically don't pay a dividend since they tend to plow most, if not all, of their available cash back into the business. This is why these companies are known as growth companies because their fortunes are rising rapidly based on a specific niche in the market that they have identified. But all that growth is expensive and spending money to reward investors with a dividend payment just can't be justified. Fail to capitalize on a specific niche and all of a sudden the expectations of investors have changed and the shares of that once high flying enterprise have started to sink. But once a company has made it and is an established player in a mature industry, the growth opportunities just aren't as great. But that doesn't mean that these behemoths aren't profitable, it only means that the opportunities to double or triple in size quickly are a thing of the past. So one thing that a mature company can do, is to reward investors for staying the course by paying out some of their cash in the form of a dividend.

Not only is it nice to get a bunch of cash back in the form of a dividend but it is also a very positive sign that management is running a tight ship if they have the stable cash flows to maintain and increase the company's dividend year in and year out. But the best reason to hold the shares of dividend paying companies is the solid returns that they have generated. A dollar invested in 1926 and held to 2004 in U.S. large-cap stock would have swelled to just under $2,300. But take out the dividends and the compounding of dividend reinvestment and that dollar would have grown to just under $88 by 2004.

Figure 1: Dividend Paying Stocks with Reinvestment Outperforms!

Dividends aren't the only way to reward investors. Another way to reward investors is through share buybacks. If a company believes that the best use of its available cash is to repurchase the shares of its own stock this is a hugely positive signal. It means that management considers its own share price too low and that a share buyback is the best use of available company funds. In 2006, it was estimated that the share buybacks on the S&P 500 companies had swelled some 23.7% from the previous year to $432 billion. The amount of share buybacks currently is up sharply from 2004 where the total amount repurchased during the year was $197 billion. That means more cash in the pocket of investors and generally higher share prices. In fact, investment research has established that companies that have paid out the highest percentage of their available cash flows to investors have outperformed those paying out less.

Figure 2: The More Generous Companies have Outperformed!

Next time some stock jock hotshot tells you about the latest hot stock he's just made a ton of money on, consider suggesting an alternative investment — a dividend paying stock that has an exemplary record of raising its dividend. Not only are you likely to make more in the long-run, but you'll be able to sleep at night knowing that each and every quarter you're getting some of your hard earned cash back in the form of a dividend while you wait for the market to realize what you already know — that dividends are divine.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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