Dividends, scoffed at not long ago as hopelessly passe by a new breed of investor, have been making a comeback of late–one that could receive a considerable boost in the coming months.
As part of a much-anticipated economic stimulus plan, President Bush is expected to announce Tuesday in Chicago a proposal to eliminate taxes on shareholders’ dividend payments. That element, which is expected to cost hundreds of billions of dollars in tax revenue in the next decade, has generated considerable controversy, with many Democrats denouncing it as a giveaway to the wealthy.
But within corporate America and among legions of individual investors, a change in tax treatment of dividends would be welcome. Companies have long complained about “double taxation”–the firm pays taxes on the profits it uses to pay dividends, and the recipients pay taxes on the money. Also, investors are unhappy that dividends are taxed at a higher rate than capital gains from stock price appreciation.
That helped to fuel a dramatic shift during the 1990s, with fewer and fewer companies paying dividends at all. But the downward trend has turned in the past couple of years, and any move to ease tax treatment of dividends would accelerate the rebound, experts say.
“There’s going to be some heat on these companies to pay dividends, because one of the excuses is being taken away from them,” said Charles Carlson, a chartered financial analyst and editor of the DRIP Investor newsletter, which examines companies with dividend reinvestment plans.
“Shareholders are going to want dividends. Companies traditionally do try to provide what shareholders want,” he said.
In the euphoric days of the 1990s bull market, what they wanted was growth. Investors shunned dividends, flocking to firms that put profits back in the business to fuel even greater stock price appreciation.
“Who was interested in 10 percent yields when your stocks were going up 50 percent?” Carlson asked.
But after three down years in the stock market and a ceaseless parade of corporate disappointments, investors said they’d welcome the relief.
“I think it would be great for a lot of people and create some opportunity for them,” said Jim Ryan, a Chicago real estate developer who bailed out of the stock market to focus on real estate investments for his personal portfolio.
Still, he said, the dividend tax cut wouldn’t be enough to make him return to equities. “With interest rates so low, real estate is a much better investment for me,” he said.
Other investors who have been flocking back to dividend-paying stocks were more excited at the prospects.
“It’s hard not to be enthusiastic about this,” said Chicago attorney Richard Weiss. “For the last couple of years, I’ve been looking for companies that pay dividends as a sign of stability. It might not be a huge dividend, but to me it’s a sign the company is moving in the right direction rather than acquiring more debt.”
Indeed, since the bull market turned into a mean-spirited bear, companies have begun to rediscover dividends. Researchers at Standard & Poor’s found that the roughly 7,000 companies traded on major U.S. stock markets reported 1,425 dividend increases in 2002, up 7 percent from 2001. Dividend decreases or eliminations totaled only 135, down 34 percent.
“The tax situation hasn’t changed … but I think where it has changed is the investor perception of what serves him or her best,” said S&P dividend expert Arnold Kaufman, noting the hunger for stock price appreciation and its more advantageous tax treatment.
“The last three years now, they’ve had second thoughts about that, and there has been a drift back toward dividends.”
Carlson, for example, notes that dividend-paying stocks have already received a boost in recent weeks as word of the Bush plan began to leak out.
For years, the heaviest concentration of dividend-paying companies has been in the so-called old economy, with technology and younger, upstart firms far less likely to send profits directly back to shareholders.
Among the 50 largest Chicago-area companies by market capitalization, 39–including the 20 largest–pay dividends, averaging an annual 80 cents per share. And 351 of the companies in the S&P 500 pay dividends, Kaufman said.
For many companies, a change in dividend tax treatment may present something of a quandary. The demands on their cash flow are heavy: Scores of investors still are looking for reinvestment for growth, corporate debt levels remain high overall, and the clamoring for dividends is likely to increase.
“There’s a careful balance between growing the business and paying out dividends,” said Brian Belski, fundamental market strategist at U.S. Bancorp Piper Jaffray.
At Deerfield-based drugstore chain Walgreen Co., which pays 15 cents per share annually, spokesman Michael Polzin said such a change could be “a significant factor” in setting rates. The company has steadily increased its dividends over a quarter of a century, but slowed the rate about a decade ago to try to fuel internal growth.
Hoffman Estates-based secondary education provider Career Education Corp., meanwhile, has not paid a dividend as it reinvested cash in the business to fuel dramatic growth, and spokeswoman Tracy Lorenz said a change in tax treatment of dividends is unlikely to change that policy.
Many companies, including tech giants Microsoft Corp., Cisco Systems Inc. and others sitting on enormous piles of cash, may feel pressure to institute at least a nominal dividend if a tax change takes effect. Some experts have speculated that this may lead to significant turnover in their shareholder bases, but Belski is unconvinced.
“I think the people who buy Microsoft will continue to buy Microsoft,” he said.
Experts are anticipating less direct effects of a dividend tax change as well. Some believe it would sharply increase dividend payouts among closely held companies. Others say it could have a significant effect on the bond market, raising yields to entice investors away from the attraction of greater dividend yields and potential price appreciation. Others say the change could lure capital away from newer, potentially high-growth companies toward more mature firms.
Many, however, said a change could also help restore faith in corporate results after a wave of scandals, and provide a litmus test for management.
“You’re not going to be paying a dividend unless you have the earnings to support it,” said Frank Felicelli, portfolio manager of the Franklin Equity Income Fund, which emphasizes high-dividend-paying firms.
“Dividend policies are … a very powerful way to indicate management’s view of the future of the company.”
