Sunday November 18 11:09 AM ET
Future Grim for Shrinking Dividends
By Elizabeth Lazarowitz
NEW YORK (Reuters) - Dividends, once a staple for stock investors looking for steady returns, may end up on a permanent vacation after falling out of favor during the long bull market.
Gone are the heady days when capital gains were all that mattered, and the stock market's sharp decline has sent many investors scrambling for more reliable returns.
But for widows, orphans, retirees -- anyone looking for investments with a guaranteed payback -- things will get tougher, analysts say. The reason: Companies are becoming more reluctant to pay out their spare cash on dividends and instead are showing a growing preference for share repurchase plans as the way to reward shareholders.
So far this year, dividends paid by companies in the Standard & Poor's 500 index (^SPX - news) have dropped 4.0 percent versus the same period in 2000. For all of last year, S&P 500 dividends fell 2.5 percent from their 1999 level, according to Arnold Kaufman, editor of Standard & Poor's Outlook investment advisory news letter.
Companies like stock repurchases because they do double duty: They reward shareholders and put a floor under stock prices. Dividends, by comparison, commit companies to making a big annual payout, regardless of the business climate.
``Managers are more than ever reluctant to increase dividends,'' said Roni Michaely, professor at the Johnson Graduate School of Management at Cornell University, who has studied dividends extensively. ``Although I sympathize with investors ... I cannot see a surge in dividends.''
Even some Wall Street stalwarts have been taking the ax to their dividends -- Ford Motor Co. (NYSE:F - news) cut its dividend for the first time in a decade last month, slashing it in half as it faced what its management called ``difficult challenges'' in the wake of the Sept. 11 attacks.
If dividends finish the year lower again, it will be the first instance of back-to-back declines since 1971, when the United States was in recession and policymakers were battling rising inflation, Kaufman said. Between 1972 and 2000, dividends rose every year, except for a one percent drop in 1991.
DIVIDEND DROP SQUEEZES INVESTORS
This is not good news for more conservative investors like Billie Taylor, 61, a retired school teacher who lives in a suburb of Dayton, Ohio and who says dividends are his primary criterion for choosing stocks.
While the drop in dividends has not been catastrophic for his portfolio, which he puts in the seven-figure range, it has been painful, particularly after AT&T (NYSE:T - news) slashed its dividend in December, 2000, he said.
``I was mad as hell,'' Taylor said. ``You have just taken away my major reason for having bought the stock and having held it all those years ... That hurts.''
The popularity of dividends, a percentage of earnings paid to shareholders in cash, dwindled during the late 1990s, with the explosion of the high-tech sector.
Investors got used to seeing firms -- particularly newer technology companies -- busily plowing any extra cash back into their businesses and paying little, if anything, in dividends.
There was also little demand for the modest-growth value-oriented stocks that comprise most of the dividend-payers at a time when it seemed the stock market had nowhere to go but up. Even more conservative investors were tempted to snap up one of the many issues offering the promise of much more substantial gains over a short period.
VALUE BACK IN VOGUE
Now, after a precipitous tumble in the market and with the Standard & Poor's 500 (.SPX) still down some 18 percent from its record peak in early 2000, slow and steady with guaranteed returns doesn't sound so bad.
The market's volatility has driven investors away from the high growth companies of the high-tech sector and into value stocks -- many of which tend to yield dividends.
So far this year, the Russell 3000 Growth Index has fallen 22 percent, while the Russell 3000 Value Index has dropped just 8.5 percent. Last year, the divide was even wider, with the growth index down 22 percent and the value index up 8 percent.
``Stocks that pay dividends are the place to be in a bear market,'' said Hugh Johnson, chief investment officer at First Albany Asset Management.
But with much of Corporate America struggling just to keep its earnings from deteriorating further, most companies simply don't have spare funds to hand out, analysts said.
``Companies feel the window to the capital markets is very narrow. They are guarding their cash,'' Michaely said. ``They are thinking 10 times before they pay out their cash, and they are thinking 50 times before they pay money to shareholders.''
RISE OF BUYBACKS
The rise of buybacks has also cut into the popularity of dividends. For companies, the advantage of buybacks is clear -- a repurchase plan gives a company more flexibility because they can buy back shares at their leisure -- or not at all.
Buybacks may be a better option for some investors, as well, because of the tax advantage they offer. Dividends are taxed as income, while any appreciation in a stock's value is taxed a the lower capital gains rate, and only when the owner decides to sell the stock.
Even for individual investors looking for a safer place to put their investments, the quality of a company's management may be a better yardstick to measure whether a stock is a good investment than how much the company pays in dividends, Michaely said.
``If someone promises you the moon, then maybe you'll get the moon, but maybe you'll get nothing,'' he added.
Not all companies have been cutting dividends, however. Some oil companies, flush with profits from high energy prices this year, have been doing just the opposite. In October, ChevronTexaco Corp. (NYSE:CVX - news) raised its quarterly cash dividend by nearly 8 percent from the third quarter.
If the United States' current economic woes evolve into a deep and protracted recession, investors may notch up the pressure on management to provide them with a more reliable return on their investments, some analysts said.
``We've been in a defensive stock market environment over the past couple of years,'' said John Forelli, portfolio manager at Independence Investments, LLC. ``Especially as earnings for companies have plummeted, equity investors need something to hold their confidence as far as valuation of securities goes.'' |
