Sometimes the simplest investment strategy is the most effective. For the third consecutive year, a conservative portfolio of dividend-paying stocks in 2005 outperformed more traditional growth stocks.
"We believe 2005 was a very good year for investors who seek dividends," said Joseph Lisanti of Standard & Poor's. "With taxes on dividends low, we expect U.S. corporations to continue to increase their payments to shareholders."
S&P reported last week that more and more companies are not only paying dividends, they are increasing the payouts. There were 1,949 dividend increases in 2005, an 11.7 percent increase over the previous year.
S&P is forecasting that there will be more than 2,000 dividend hikes in 2006, the first time since 1999 that threshold has been topped.
"In the U.S. market, we expect equities to respond positively to the end of the Fed tightening cycle, especially at a time when productivity continues to be healthy," said Thomas Sowanick, chief wealth management strategist at Merrill Lynch (NYSE: MER).
"Moreover, companies appear to be poised to increase their earnings at an above average clip for a fifth year in a row, which suggests that dividend payouts will be healthy again in 2006. In that regard, stocks seem to be inexpensive in relation to bonds, and their income-growth potential appears to be greater than that of current bond yields," said Sowanick.
One of the companies increasing its payout to investors in 2005 was Bank of America (NYSE: BAC). In June the company raised its quarterly dividend from 45 cents to 50 cents.
CEO Kenneth Lewis said that the announcement "marks the 28th consecutive year of dividend increases. We are very proud to offer our shareholders one of the most reliable and rewarding dividend payouts records in American business."
With the increase, Bank of America's annual dividend yield rose to 4.25 percent. That compares to the dividend yield of the S&P 500 of 2.01 percent. It also makes Bank of America a "dividend aristocrat," a company that has raised its distribution for at least 25 consecutive years. Fewer than 50 of the 7,000 companies tracked by Standard & Poor's qualify as aristocrats.
One of the reasons for the popularity of dividends is the preferential tax treatment they receive. The Jobs and Growth Tax Reconciliation Act of 2003 cut the tax treatment on qualified distributions from ordinary income -- as high as 35 percent on the federal level -- to a maximum of 15 percent.
However, that provision is due to expire in 2008 unless Congress acts to make the change permanent. Appropriate legislation is pending in Congress. No doubt, dividend stocks would lose some of their luster if the tax status isn't protected.
"Considered to be relics of an earlier age during the bubble years, dividends have received increased attention over the last three years, largely coinciding with the change in the dividend tax laws," said Smith Barney analyst Marshall Kaplan in a report called "Don't Discount the Dividend."
"Looking ahead, we believe that dividends will play a more significant role for investors, particularly if future price returns do not exceed low single digits," said Kaplan. That was evident in 2005, when the Dow Jones Industrial Average was basically unchanged but the Dow Utility Index -- a portfolio of 15 utility stocks with handsome dividends -- rose by more than 22 percent.
The Smith Barney report shows that over the past 100 years dividends have accounted for nearly half of the total annual return of the S&P 500.
Real estate investment trusts are another popular source for dividend income. Pan Pacific Retail Properties (NYSE: PNP), a Vista-based REIT, saw its stock go from $57 a share at the start of 2005 to $68 at the end of the year. It still generates an above average dividend yield of 3.5 percent.
The popularity of dividends has also led to the creation of a significant number of mutual funds, including exchange traded funds. The Dividend Achievers Index, which trades on the American Stock Exchange under the symbol "DAA," was created by Mergent to track the performance of companies that have increased their annual payouts for at least the past 10 years.
"At a time when so much of corporate America is under attack, these companies demonstrate management and board success stories and attention to their shareholders interest," said Jonathan Worrall, Mergent CEO.
"Not only do these companies represent the very best of U.S. stocks, but as a group they offer a relatively low-risk investment, and of course there are significant tax breaks that further increase the potential yield to the ordinary investor," said Worrall.
Chamberlin's financial analysis column appears each Monday in The Daily Transcript. Chamberlin also reports daily on stocks and local business on NBC 7/39 and on "Money In The Morning" on KOGO 600 AM. Send comments to email@example.com. All letters are forwarded to the author and may be used as Letters to the Editor.