Not every sexy makeover is on reality TV. There’s one going on right now in the stock market.
Stocks that pay dividends used to attract mostly older Americans on fixed incomes patiently awaiting payouts from sturdy utility stocks.
A transformation of the stock dividend from duckling to swan occurred when Congress approved President Bush’s tax cuts last year. The top tax rate on dividend income dropped to 15 percent from 38.6 percent, retroactive to the beginning of 2003.
Dividends suddenly became a hot attraction for average investors. The typical company issuing them is also considered a real catch: Cash-rich with a stable reputation. In a hesitant market, dividends give investors something extra in their pocket while they wait for the real action to begin.
Microsoft’s special $32 billion one-time dividend payment of $3 a share and doubling of its regular dividend to 32 cents a share spotlighted this dividend-friendly environment, but the love fest has been widespread.
Popular companies such as Wal-Mart Stores and PepsiCo have increased their dividends, while first-ever dividends have been issued by the likes of Outback Steakhouse and FedEx.
“The market recovery had favored lower-quality, lower-priced, lower-dividend companies, but we’ve recently seen that mind-set change,” observed Richard Cripps, chief market strategist for Legg Mason Wood Walker in Baltimore. “The S&P 500, representing bigger companies with higher dividend yields, drew closer in performance to the Russell 2000 and is now outperforming it.”
Yet dividends could lose their good looks if the current tax treatment faded away.
Democratic presidential candidate John Kerry has said that as president he would seek to repeal capital gains and dividend tax cuts “to the extent that such income causes a family’s income to exceed $200,000.”
Long-term capital gains for such families would be taxed at 20 percent or, if assets are held more than five years, at 18 percent. Dividends would be taxed at a family’s marginal income tax rate.
“Companies are looking to pay out more dividends, especially in this election year because Sen. Kerry is on record as saying he’d be rolling back the tax cuts,” explained Martin Nissenbaum, national director of personal income tax planning for Ernst and Young in New York. “You’re certain your dividends now will qualify for the new lower rate this year, while no one really knows what will happen after the election.”
Even with a Kerry White House, a rollback of the dividend tax cut isn’t certain.
“If Kerry becomes president, he’d need a Democratic majority in the Senate and possibly even in the House, which isn’t likely to happen,” said Sam Stovall, chief investment strategist with Standard & Poor’s in New York. “He’d need more votes than he’s probably going to get in order to overturn President Bush’s tax plan.”
Average dividend yield for S&P 500 stocks is 1.79 percent, compared with 1.1 percent in March 2000. Fast-growing industries such as technology have traditionally plowed their cash into research and development, not payouts to shareholders.
“There is no free lunch, so a stock with a dividend 2 to 3 percent higher than the average yield for its sector can be an indication investors don’t think that dividend is sustainable,” cautioned Chuck Carlson, editor of the DRIP Investor newsletter (www.dripinvestor.com) in Hammond. “You’re best off focusing on stocks with decent yields and nice dividend growth as opposed to buying the highest-yielding stocks.”
Shares of Bank of America (ticker BAC), dividend yield recently 4.29 percent, are recommended by Carlson and Cripps. The bank increased its dividend by more than 10 percent each year for the past decade and just raised it another 15 percent this year. Its merger with Fleet Financial has made it a truly national business growing at a solid clip.
Wells Fargo (WFC), recently 3.4 percent, is another favorite Carlson banking stock, while his top energy picks are ChevronTexaco (CVX), recently 3.34 percent, and ConocoPhillips (COP), recently 2.27 percent. Meanwhile, Cripps’ favorite dividend-paying stocks are Alltel (AT), recently 2.87 percent, and General Electric (GE), recently 2.48 percent.
Maintaining dividend yield is a priority.
The highest-yielding stock on the S&P 500 is a real estate investment trust, Chicago-based Equity Office Properties (EOP), recently yielding 7.59 percent. REITs, which manage real estate properties, must distribute at least 95 percent of their income.
Although declining rents and occupancies at office and industrial properties will leave Equity Office Properties $179 million short of covering its dividend, it has no plans to cut it. Chief Financial Officer Marsha Williams said there’s enough cash on hand and a dividend cut wouldn’t make sense with office markets beginning to recover.
The second-highest-yielding S&P 500 stock is another REIT, Apartment Investment and Management (AIV), recently yielding 7.51 percent. Other strong yields include telecom AT&T Corp. (T), recently 6.7 percent; electric utility Ameren Corp. (AEE), recently 5.66 percent; and tobacco firm Reynolds American (RAI), recently 5.23 percent.
The analyst consensus stock ratings are a weak “buy” for Ameren and Reynolds American; a “hold” for Equity Office Properties; and a weak “hold” for AT&T and American Investment and Management.
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Real estate, tobacco top dividend leaders
Top dividend providers by sector among S&P stocks. The average dividend is 1.79 percent.
%% Industry Yield
Real estate investment trusts 6%
Tobacco 5.6
Gas utilities 4.3
Baby Bell telecom companies 4
Electric utilities 3.8
Source: Standard & Poor’s Corp.
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