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Investors can reap rewards from dividends, stock buybacks

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America's publicly traded companies are sitting on a mountain of cash – somewhere well in excess of $2 trillion -- and shareholders are demanding they get a piece of the pie.

As a result, companies are ramping up two strategies that reward investors: dividends and stock buybacks. Dividends reward investors with quarterly cash distributions while stock buybacks reduce the number of outstanding shares, therefore increasing the value of remaining shares.

A recent report from Standard & Poor's showed 444 of the approximately 7,000 publicly traded companies that report dividend distributions raised their payouts to shareholders in the second quarter of 2011, an increase of 32.5 percent over the same period a year earlier.

Only 21 companies reduced their distributions during the second quarter, down from 34 in the same period in 2010.

“If dividends were a paycheck, dividend investors would have received an 11.1 percent raise in the first half of 2011. Dividend increases are commitments not just to current payments but to upcoming obligations.

Companies need to be sure that their earnings and cash flow will continue into future periods to satisfy payments,” said Howard Silverblatt, senior index analyst at S&P.

The importance of dividends to the total return of stock market investing is significant. According to S&P, dividends have represented 43.4 percent of the average return generated by the S&P 500 stock index between 1926 and 2010.

“Dividends are often underappreciated by investors who see companies that pay out sizable, steady dividends as sleepy and sluggish, in contrast to the dynamic aura that surrounds archtypical growth stocks. Some other investors do prize dividend-paying companies for their contribution to total return as well as for their ability to generate income,” said David Ruff, portfolio manager for Forward Management.

The ability of a company to pay dividends – and increase them on a regular basis – is a sign of financial stability and management discipline. Before a company can pay shareholders it must obviously generate significant revenues to meet the obligation.

“A company that pays dividends, therefore, is profitable. If a company has a rising dividend trend, it stands to reason that there must be a sufficient increase in earnings to justify the dividend increases,” said Kelley Wright, managing editor of Investment Quality Trends, a newsletter on dividend investing based in Carlsbad.

However, some companies are still hesitant to share their large cash positions with shareholders. In its most recent quarterly report, Apple (Nasdaq: AAPL) indicated it holds nearly $43 billion in cash and short-term securities. Yet, the company refuses to initiate a dividend to shareholders.

Another technology company that refused to reward shareholders with distributions, Cisco Systems (Nasdaq: CSCO), finally initiated a quarterly dividend. When Cisco Systems reported financial results in May it had more than $43 billion in cash assets.

“The time is right for Cisco to pay our first-ever cash dividend. This dividend complements our leading position and it is an important part of our commitment to bring value to our shareholders,” said Frank Calderoni, chief financial officer at Cisco when the company announced the payout in March.

Another way to bring value to shareholders is through stock buybacks. This involves using funds to purchase outstanding shares of stock in the open market. By reducing the number of shares in circulation it enhances quarterly earnings and, over a period of time, make the remaining shares more valuable.

S&P reports companies increased buybacks in the first quarter of 2011 to $89.8 billion, up from $55.3 billion during the same period a year earlier.

However, a growing number of investors and money managers say they would prefer increasing dividends rather than pouring money into stock buybacks.

“In our estimation, buybacks are often implemented when the share price is too high. As such, we would prefer to receive the cash and then buy shares in another company that offers good historic value. If you will remember, stock buybacks were all the rage in 2007 and even into 2008. For many companies with ongoing buyback programs, shares were purchased at the top of the market. Needless to say, this capital could have been spent in a much wiser fashion,” said Wright.

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