Payout time, at least for now
For investors, one encouraging note in President Obama’s budget proposal this week was his commitment to retain most of the Bush administration’s tax break on dividends.
That will matter, however, only if there is enough dividend income left to get that break in the next few years.
U.S. companies are hacking cash payouts to shareholders at a vicious pace as the economy’s deep dive slashes sales and earnings.
General Electric Co. on Friday became the 34th big-name U.S. firm this year to cut its dividend. The conglomerate said it would reduce its quarterly payment 68%, to 10 cents a share, from 31 cents.
The move will save GE $9 billion a year -- money it can use to bolster its finances in case the recession worsens.
But the cut also means that the company’s many shareholders, from large pension funds to small investors with just a handful of shares, will be $9 billion poorer each year.
Dividend reductions by GE, Pfizer Inc., Dow Chemical Co., Macy’s Inc., CBS Corp., Harley-Davidson Inc. and other corporate giants in recent weeks have added insult to injury for shareholders in this 16-month-old bear market, which reached new lows on Friday.
First you endure the pain of watching your stock’s market value vanish. Then the company takes away all or most of the dividend.
Last year, dividend cuts were centered in the sinking financial industry. This year they’ve gone more mainstream.
The reduced payouts by 34 companies in the Standard & Poor’s 500 index this year compare with just eight in the first two months of last year.
And when the cuts are on the scale of GE and Pfizer, the damage they do in the economy stretches across years. For shareholders who relied on that money, “it’s a pay cut every year from now on,” said Howard Silverblatt, index analyst at S&P; in New York.
We aren’t just talking about the rich here. Plenty of average retirees down the wealth scale have long owned blue-chip, dividend-paying stocks as a way to generate regular -- and rising -- income.
The good news is, many of those bets still are paying off as hoped: Although this may end up the biggest year for dividend cuts since the Great Depression, according to S&P;, many firms are continuing to raise their payouts even in the face of the economy’s woes.
On Friday, consumer-products titan Colgate-Palmolive Co. boosted its quarterly dividend to 44 cents a share from 40 cents, a 10% increase. Industrial products manufacturer ITT Corp. last week lifted its quarterly payout 21%, to 21.25 cents a share.
In all, 45 companies in the S&P; 500 have boosted dividends this year, outnumbering the 34 that have cut.
Josh Peters, who tracks dividends for investment research firm Morningstar Inc. in Chicago, offers an interesting proposition: Companies that stay committed to paying and increasing dividends could gain star status with investors in the years ahead.
That would require that people think about stocks the way they were viewed in bygone eras: “You should look at a stock as a claim on the company’s income, not as a growth vehicle,” Peters says.
Until the 1980s, dividends had long been a key focus for many investors as they shopped for stocks. That changed as the bull market charged ahead in the ‘80s and ‘90s, and as stock options rose to prominence as a form of compensation for managers.
As investors and managers got used to huge recurring capital gains, dividends faded in importance for most stocks.
Now, with the S&P; 500 index back to levels last seen in 1996, capital gains are a distant memory. And it’s becoming harder to imagine stock prices zooming again any time soon, even when the recession ends: With high debt levels likely to weigh on the economy for many years, the nation (and world) might at best expect a painfully slow recovery that keeps corporate earnings, and share prices, subdued.
If that’s what we’re facing, the promise of growing dividends may well become a primary marketing tool for companies hoping to lure investors to their shares.
For the moment, individual investors looking for income and relative safety are turning to corporate, municipal and government bonds. Purchases of bond mutual funds have surged this year.
And investors who want to take no risk at all are staying in money market funds or bank accounts, where they’re earning dismally low yields.
Stocks can’t offer that kind of safety, of course. But with annualized dividend yields on many S&P; 500 stocks exceeding 3%, that’s a decent income return. More important, because dividends can grow over time, they offer a significant long-term advantage over bond interest, which is fixed for the life of the bond.
And because Obama would keep the low 15% top tax on dividends for all but the wealthiest folks, dividends would maintain their tax advantage over bond income, which is taxed at ordinary rates.
Investors will never give up hoping for capital gains from equities. But dividends -- at least when you can depend on them -- should become more appreciated as the proverbial bird in the hand.