Well-chosen stocks that pay dividends are solid investments. They are a little less volatile, or risky, than the market as a whole. They produce slightly worse returns in good times but significantly better returns in bad.
And dividends don’t lie. Companies can pull all sorts of shenanigans to make their earnings look good in the short term, like pushing expenses into future years. Dividends are real cash sent to shareholders.
Consider “Dividend Aristocrats.” These are large companies in the S&P 500 that have increased their payouts each year for at least the past 25. Currently, there are more than 60 such stocks that compose the S&P Dividend Aristocrats index, which gives equal weight to each. You can buy the index through ProShares S&P 500 Dividend Aristocrats, a diverse exchange-traded fund. By sector, the list of Dividend Aristocrats isn’t much different from the market as a whole—with two exceptions. The Aristocrats are light on technology and heavy on consumer-staples stocks.
The Aristocrats aren’t the only dividend stocks worth considering. Fidelity Dividend Growth is a mutual fund that owns stocks with a history of payout growth, but it has no hard-and-fast requirements.
Hiking a dividend payment every year is an indication that a company is a consistent earner. It may also mean that the company is disciplined—its managers know how to boost revenues and earnings but don’t take inordinate risks. On the other hand, when a company distributes a high proportion of its profits to shareholders, it could be admitting that it can’t put that capital to work itself to produce high returns.
Dividend yields have been paltry in recent years compared with the past. Between 1970 and 1990, the average dividend yield for the S&P 500 was 4 percent. It dropped to 1.9 percent between 1991 and 2007, and it has been about there, or lower, since—with the exception of early 2009, when it hit 3.4 percent as stock prices dropped sharply during the Great Recession. With low interest rates on bonds, stocks did not need large payouts to attract investors.
Today, however, a yield of 2 percent doesn’t seem so juicy when five-year Treasury notes are yielding almost 4 percent. But remember that while bonds pay the same interest every year, dividend payouts tend to rise. Of course, bond income is a promise; stock dividends are not. Major corporations and governments rarely default on their debts, but corporate payouts are often cut or eliminated when times are tough.
Be aware that high dividend yields—calculated by dividing the annual payout by the stock price—can be a danger sign. A big price drop lowers the denominator and raises the resulting yield, and a falling price is usually a sign of trouble ahead.
(James K. Glassman is a contributing columnist at Kiplinger’s Personal Finance magazine. For more on this and similar money topics, visit Kiplinger.com.)
