Personal Finance: Dividend often marks best investment picks

Personal Finance: Dividend often marks best investment picks

May 25th, 2011 Travis Flenniken in Business Diary

Dividends are often thought of as merely a nice sweetener to the investment return expected to be garnered from a stock's price appreciation. Dividend-paying stocks have gone in and out of favor over the last five decades, losing their appeal in periods of strong economic growth, but considered a safer investment in times of uncertainty.

According to recent research, it turns out that dividends have played a major part in investment performance over time. Total return from an investment includes the price appreciation of the investment and the income it generates. A study provided by International Strategy and Investment explains that 53.8 percent of the stock market's total return since 1930 is attributed to dividends alone.

According to a study by Ned Davis Research Inc., dividend payers have outperformed nonpayers in four out of the last five decades, with the only exception being the 1990s. Dividend-paying companies also have outperformed nondividend-paying

stocks with considerably less volatility in the period between December 1973 and March 2011.

Dividend growers and initiators had an annualized total return of 9.6 percent and a standard deviation of 17.2, while the nondividend-paying stocks returned 1.7 percent and a standard deviation of 25.9. Standard deviation is a measure of risk, so the higher the number, the more volatile the price.

Many economists believe the Federal Reserve will take action in the next 12 months and begin tightening money supply by raising the Federal Funds rate.

If history is a guide, dividend-paying stocks may be the best investment in a rising-rate environment. Going back to 1972, when the Fed tightened monetary policy, dividend-paying stocks gained an average annual rate of 2.2 percent versus 1.8 percent for nonpayers.

In periods of easing or neutrality, annual returns from dividend payers doubled the returns of nonpayers on average.

Examining current dividend yields relative to bond yields would indicate that it may be a good time to invest in stocks with a strong dividend.

The spread between the yield of the 10-year Treasury and the dividend yield of the S&P 500 is tight by historical standards.

Dividends paid by companies comprising the S&P 500 are yielding 2 percent, while the 10-year Treasury's yield is about 3.1 percent, making the spread 1.1 percent. Compared to the 35-year average spread of 4.4 percent, stock dividends appear to be fairly robust relative to bond yields.

Among the various sectors within the S&P 500, the telecommunication and utility sectors are generating the highest average dividend yield, paying 5 percent and 4.2 percent, respectively.

Consumer staples, which include companies that make food, tobacco and pharmaceuticals, are paying a 2.9 percent yield. Financials, which prior to 2008, paid nearly 30 percent of all dividends in the S&P 500, currently account for only 9 percent of the total and are yielding only 1 percent.

Stocks that consistently pay a dividend have historically been a good long-term investment in times of turmoil as well as in growth periods. In the current economic climate, where many expect a period of slower economic growth and few attractive fixed income investment opportunities, stocks with a high dividend yield are a compelling investment idea.

Travis Flenniken, a chartered financial analyst, is vice president of investments at DeMoss Capital. If you have personal finance questions, you may send them to Business Editor Dave Flessner at dflessner@times freepress.com or mail them to Dave Flessner, Times Free Press, 400 E. 11th St., Chattanooga, TN 37402.