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many investors, the lesson of the Enron scandal is never to trust
a company's earnings reports and balance sheets again. But that's
nonsense. Yes, there are unscrupulous corporate managers and auditors
out there, but the best way to protect yourself is not to dump stocks
and buy Treasury bills but to diversify broadly and look carefully
at the numbers. Here's a suggestion: Look to dividends. In other
words, show me the money.
Enron paid
dividends all during the period when it now admits that it was overstating
earnings, but those payouts were curiously flat at a time when the
company's reported profits were soaring. For example, between 1997
and 2000, earnings rose 69% but dividends rose just 9%. That could
have been a sign that something fishy was happening. A company might
be able to fake out analysts by booking today paper profits that
might possibly occur in the future. But dividends aren't entries
on the ledger; they're real money. A company that consistently raises
its dividend is almost always a well-managed company in a strong
market niche.
Franklin Rising
Dividends, a mutual fund that looks for firms with "consistent
and substantial dividend increases," returned a spectacular
13% last year, beating the benchmark Standard & Poor's 500-stock
index by 25 percentage points. Its top holdings include Family Dollar
Stores Inc., the discount retailer; Washington Mutual Inc., the
largest thrift in the United States; and Alberto-Culver Co., a toiletries
company.
Just as impressive
is Fidelity Dividend Growth. With a similar strategy, it has produced
returns averaging 15% over the past five years, beating the S&P
by 5 points — and at considerably lower risk than the market
as a whole. A third excellent fund in the same category, T. Rowe
Price Dividend Growth, has soundly beaten the market over the past
two years, again at relatively low risk. Large holdings include
well-known large-capitalization stocks such as Pfizer Inc., Citigroup,
General Electric Co., and Exxon Mobil Corp.
Unfortunately,
dividends are getting more scarce. In 2000, a good year for profits,
total dividends paid by the companies in the S&P 500 (roughly
the 500 largest U.S. firms) fell 2.5%. In 2001, the decline was
3.1% — the first time there's been a back-to-back drop in 30
years. And, for the first time ever, more than one-quarter of the
S&P companies are paying no dividends at all. That's hardly
surprising. Academic research shows that investors haven't been
particularly enthusiastic about dividends — mainly because
of the way they're taxed. First the corporation has to pay taxes
on its profits, then it pays dividends on what's left and investors
pay taxes on the dividends. (The way around this double taxation
is to own your dividend-paying stocks in tax-deferred accounts such
as 401(k) plans and individual retirement accounts.)
Double taxation
encourages companies to hold on to most of what they earn, whether
the companies really need the money or not. While many firms use
their profits wisely, investing in new plants and equipment from
which more profits can be gleaned, others simply build up giant
cash hoards or squander the funds on wasteful expansion. As Peter
Lynch, the former manager of the Fidelity Magellan fund, once wrote,
"Companies that don't pay dividends have a sorry history of
blowing the money on stupid diversifications" — like cash-rich
Mobil's disastrous 1976 acquisition of Marcor, the holding company
for Montgomery Ward, a retail chain that eventually went bankrupt.
Another popular
way for corporations to dodge double taxation is to use their profits
to buy their own stock. With fewer shares outstanding, each outstanding
share is more valuable — the equivalent of a tax-free stock
dividend.
Still, taxes
or not, I like dividends. They add ballast to a portfolio, holding
down losses in tough times. Thomas Huber, who manages the T. Rowe
Price fund, says: "Dividends are the only portion of stock
return that is always positive. Earnings growth and share price
appreciation certainly are not. This has been the painful lesson
of the last year." With the combination of two years of declining
stock prices plus the Enron scandal, the show-me-the-money approach
should become more popular in the months and years ahead.
Yes, but the
typical stock's dividend yield — that is the annual payout
as a percentage of the stock's price — has become minuscule.
In 2000, the average S&P stock paid a dividend that was just
1.1% of its purchase price — the lowest figure in market history.
This year, because the prices of S&P stocks took a big tumble,
yields rose a bit — but only to 1.4%, the third-lowest ever.
For the past 60 years, yields have been dropping sharply. In the
1940s, they averaged 5.9%; in the 1970s, 4.2%; in the 1990s, 2.6%.
Still, it's
possible to find strong companies with decent dividends. Dow Theory
Forecasts, a newsletter with a leaning toward such firms, recently
listed eight stocks with yields of at least 2% and dividends that
have increased by at least 45% over the past five years. They are
Bristol-Myers Squibb Co., pharmaceuticals; Caterpillar Inc., construction
equipment; Duke Realty Corp., commercial real estate; Emerson Electric
Co., electronics; KeySpan Corp., natural gas distribution; Merck
& Co., pharmaceuticals; Philip Morris Cos., cigarettes, beer,
food; and Popular Inc., a Puerto Rican bank.
At a time when
two-year Treasury notes are yielding about 3%, the yields of many
of these stocks are enticing. For example, KeySpan last week declared
a quarterly dividend of 44.5 cents per share — or $1.78 for
a full year. The stock closed Wednesday at $30.82, for a yield of
5.8%. Duke is a typical real estate investment trust, or REIT, which
by law has to pass nearly every penny of its profits on to shareholders
in the form of dividends. Duke's dividends this year are expected
to total $1.80, and it trades at $23.83, for a yield of 7.6%.
But don't be
deceived by REITs. On average, companies pay out about one-third
of their profits in dividends, so, when bad times hit, they have
a cushion. There's still cash to keep the dividend steady, and most
conventional firms are extremely reluctant to cut their payouts
— it's a sign of terrible weakness. REITs, however, pay out
95% of their earnings, so, when business falls off, the dividend
usually gets cut. It's wise, then, to check the REIT's past performance
to see that it has a track record of rising dividends. In Duke's
case, the record is superb: Dividends have increased every year
since the company went public in 1993. By contrast, Crescent Real
Estate Equities, a Texas-based REIT, currently yields a stunning
8.7%, but it was forced to cut its dividends in 1999, 2000, and
2001 — not a good sign. In general, however, REITs offer a
steady flow of cash.
What you do
with that cash is up to you, but reinvesting it in more stock can
pay off in spectacular ways. T. Rowe Price researchers calculated
that an investor who put $1,000 into the S&P 500 stocks in 1982
had accumulated $16,597 by 2001. But $7,100 of that gain came from
reinvesting the dividends — however puny — the shares
threw off. In other words, $2 out of every $5 ended up coming from
dividends.
Some companies
are true dividend heroes. Dow Chemical Co., for example, has paid
a dividend every quarter since 1911. It's currently yielding 4.6%.
Procter & Gamble Co., Minnesota Mining & Manufacturing,
Johnson & Johnson Inc., and Genuine Parts Co. have each increased
their dividends annually for at least 40 years. Tootsie Roll Industries
Inc., one of my favorite companies, has boosted dividends for 37
straight years.
And don't forget
that, as dividends grow over time, so does the annual return on
your original investment. For instance, T. Rowe Price points out
that if you had invested in Schering-Plough Corp. 20 years ago,
your annual dividend today would amount to a yield of 63% on the
money you first invested — and that percentage will continue
to rise. Last year's dividend payment from Philip Morris actually
exceeded the stock's price 20 years ago, so an investor would be
making an annual return of more than 100% on the dividend alone.
But don't get
carried away with dividend-paying stocks. You can certainly do very
well owning stocks that pay little or nothing to shareholders. After
all, the No. 1 stock over the past 10 years — Dell Computer
Corp., up 7,800% — pays no dividend at all.
Still, in times
like these, you should want to see the money. Get in the habit of
scanning lists of recommended stocks for companies that pay decent
dividends. For instance, the Focus List of Raymond James Associates
Inc., an investment firm with a strong track record for picking
winners, includes Fannie Mae, the huge mortgage financier, currently
yielding 1.6%; Chubb Corp., insurer, at 2%; and Stanley Works, toolmaker,
2.2%.
Of course,
no dividend is guaranteed, but there's an excellent chance that
a company's payouts will continue — and grow. Two percent may
not sound like much, but it's nice to have something to count on
in a turbulent market.
—
Among the companies named, Mr. Glassman owns of ExxonMobil, General
Electric, and Dell Computer. His new book is The
Secret Code of the Superior Investor. This column originally
appeared in the Washington Post.
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