Bear Market Creates New Appreciation of Dividends

In search of better yields on their savings, some investors may wind up in an unlikely place: the stock market.

If it’s income you want, it’s available from stocks that pay regular cash dividends. Ignored for most of the late-1990s as share prices rocketed, dividends have become respectable again--which was their status on Wall Street for most of the 20th century.

The dividend on shares of banking giant J.P. Morgan Chase now provides an annualized yield of 4%; energy firm Chevron’s dividend yield is 3.1%; Ford Motor’s yield is a whopping 6.9%, far above what most bank CDs pay.

There are, however, plenty of caveats involved with dividends, starting with this overarching warning: Stocks, even those that have paid steady dividends for decades, provide no guarantees at all about the security of their dividend or about your principal. Stocks are risky. Period.

Indeed, Ford cut its annual dividend to $1.20 a share late last year, from $2, trying to conserve cash as auto sales began to weaken. Last week, United Airlines parent UAL indefinitely suspended its 5-cents-a-share quarterly dividend.

Still, dividend cuts among major companies are relatively rare, because they send such a bad message to shareholders and potential shareholders.

A key reason many companies have paid cash dividends over the years is to reduce the perceived risk of owning their shares. Though most investors buy stocks hoping for some kind of capital appreciation over time, that isn’t a sure thing--as so many people have learned the hard way over the last 18 months.

A dividend, by contrast, is cash that comes back to you each quarter from the earnings the company generates on your behalf. (As a shareholder, after all, you are one of the company’s owners.)

For most of the last century, dividends held a place of high esteem in the investment world. It was expected that high-quality companies would pay decent dividends, and annual yields on many blue-chip shares were 5% or better.

But companies--and investors--began to take a different view of dividends in the 1990s. Many firms still paid dividends, but annual increases became less generous. More corporate managers came to believe that they could better boost their stock price by retaining earnings to reinvest them in the business or to buy back stock, rather than paying big dividends to shareholders.

Many investors agreed, in large part because federal tax law favored (and still favors) capital gains over ordinary income such as dividends.

Yield on S&P; 500 Remains Paltry

Even as companies turned stingier with dividends in the 1990s, share prices zoomed. The combination of sky-high prices and meager dividend payments pushed the yield on the S&P; 500 index to record lows by 1999. The yield was 1.15% at the end of that year.

The S&P; yield now is 1.5%, well up from the low but still paltry in the scheme of things.

From 1930 through the 1980s, dividend income comprised a significant chunk of the “total return” investors earned on stocks.

Americans have been conditioned to believe that the stock market will provide annualized returns of 10% to 11% in the long run, because that was the case in the last century.

What most probably don’t realize is that about half that historic return came from dividend income on stocks; the other half was capital appreciation.

In the 1940s, the S&P; 500 produced an annualized total return of 9.2%, according to Ibbotson Associates. About two-thirds of that was from dividends, the rest from capital gains.

Those components reversed in the 1950s, when share price appreciation accounted for more than two-thirds of the S&P;’s 19.4% annualized total return.

But in the 1960s, the annualized return of 3.3% generated by dividends on the S&P; 500 made a big difference once again, as share price appreciation dwindled to a 4.4% annualized rate.

Even in the roaring 1980s, dividends on the S&P; generated a 4.6% annualized return, far above the current average blue-chip yield.

Using History as a Weapon

Some of Wall Street’s biggest pessimists brandish history as a weapon. They say the lack of meaningful dividend yields on most stocks assures that the market’s total return will be subpar in this decade.

But that assumes that the 1990s were an anomaly in terms of how investors view dividends and in terms of how much they’re willing to take dividends into account in judging what to pay for stocks.

One of the market’s top authorities on dividends believes the ‘90s weren’t an anomaly, but the start of a lasting trend.

Arnold Kaufman, editor of S&P;’s Outlook investment newsletter in New York and a veteran dividend-watcher, doesn’t expect the majority of institutional or individual investors to be clamoring for dividend income as they did in, say, the 1940s or ‘60s.

“It’s just not going to happen,” Kaufman said.

Most investors, he said, still believe that it’s better to leave the bulk of earnings in the hands of corporate managers. And the substantial tax break for capital gains means investors will continue to pick stocks primarily for the price gains they might generate rather than for higher dividends, Kaufman said.

Nonetheless, if share price gains are much harder to come by in this decade, for whatever reason, more investors may slowly begin to appreciate dividends, he said.

For those investors who have a need for decent dividend income today, the good news in the stock market’s slide of the last 18 months is that lower share prices have boosted dividend yields on many issues.

Of course, what constitutes a “good” yield is a matter of perspective. But the deeply depressed yields on money market funds, bank CDs and Treasury bonds make many stock dividend yields appear generous.

The allure of dividends, however, isn’t simply in what they are today. It’s the prospect of rising dividend payments over time that attracts investors, or should.

That also is what can make dividend income appealing versus bond income. A bond pays a set amount of interest each year until it matures. So an investor is stuck with whatever initial yield he or she gets.

With dividends, however, increases in the payout over time mean the yield on your original investment can rise. Among other things, that provides inflation protection.

Consider the case of an investor who paid $43 a share for Chevron in 1994, when the stock traded between $40 and $47. The annual dividend Chevron paid per-share that year was $1.85. So the yield at $43 a share was 4.3%.

Today, Chevron’s annual dividend rate is $2.60 a share. For someone who paid $43 a share, the dividend yield on those shares now amounts to 6%. Meanwhile, Chevron’s share price has about doubled since 1994.

Tips for Seeking Dividend-Paying Stocks

Dividends will never be the only reason most investors buy stocks, but the bear market of the last 18 months has added some new luster to the idea of getting a cash return of some kind on your shares.

As Kaufman puts it: “It’s comforting to at least have that dividend in your pocket.”

If you’re shopping for dividend-paying stocks, here are a few things to keep in mind:

* Utilities and real estate investment trusts offer some of the highest yields of any industry sectors, which has been the case historically as well. But investors should carefully research the ability and willingness of individual utilities and REITs to maintain or increase their dividends. Don’t assume that increases in these sectors are foregone conclusions.

* Yields on many heavy-industry and financial stocks are high today, but that reflects investors’ concerns that the economy will sink into a deep recession that could cause the companies to cut their dividends to preserve cash. Again, basic research is crucial in picking these stocks if the dividend yield is a key focus.

* Many investors wonder about so-called preferred stocks issued by major companies. The yields often are high, but these shares are viewed by market pros as bond substitutes: Dividends on preferred issues typically don’t rise over time, as they can on common stocks, and preferred shares usually offer little in the way of price appreciation.

Moreover, companies often can “call” preferred stocks--meaning the shares can be retired (called in and paid off) long before their investors expect.

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Higher Yields Than Money Funds

Here is a sampling of big-name stocks with annualized dividend yields higher than what most money market funds are paying. Dividend yield is calculated by dividing the dividend by the stock price. All of these companies, except MetLife (which came public in 2000), also have long histories of rising dividends.

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Ticker Recent Annual Div. Company symbol price dividend yield Southern Co. SO $23.98 $1.34 5.6% Progress Energy PGN 42.99 2.12 4.9 Philip Morris MO 48.29 2.32 4.8 J.P. Morgan Chase JPM 34.15 1.36 4.0 PPG Industries PPG 45.75 1.68 3.7 Wilmington Trust WL 55.20 1.92 3.5 PNC Financial PNC 57.25 1.92 3.4 Chevron CHV 84.75 2.60 3.1 MetLife MET 29.70 0.80 2.7 Avery Dennison AVY 47.31 1.20 2.5 S&P; 500 index 1,040.94 15.68 1.5

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Source: Standard & Poor’s Corp., Times research *

Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to https://www.latimes.com/petruno.