At one time considered to be an integral aspect of an investor’s portfolio, stock dividends have taken a back seat in recent years as investors turned to shares that offered greater capital appreciation. The current volatile market, however, has highlighted the value of including dividend-paying stocks in a balanced portfolio. This is especially true in light of the fact that the benchmark for the U.S. market, Standard & Poor’s 500 Index, has in effect delivered flat returns since 2000.
Dividends are paid to a corporation’s shareholders when it earns a profit or surplus. Corporations generally retain a portion of their earnings by re-investing in the business and pay the remainder as dividends to shareholders. Although dividends are usually paid out on a cash basis by the company to the shareholder, they can also take the form of stock credits, which is a common practice among retail consumers’ cooperatives. As an alternative to a cash payout, which is taxable, some companies offer dividend reinvestment plans that allow shareholders to buy stock. This is usually done with no commission payable and sometimes at a discount and is generally, but not always, tax free.
Dividend reinvestment plans, which can be seen as retained earnings, have both critics and supporters. Some investors and portfolio managers see this as the management of the corporation dictating to shareholders how they should invest their money, while others, Warren Buffet included, favor retained earnings over dividends primarily because of the less punitive tax regime that applies to them. Reinvestment in a company may also be seen as the management of the company having confidence in its future.
In theory, dividends should support a portfolio in the event of a market downturn. This is because even if a company’s share price falls, it will more than likely still make a dividend payout, which could offset losses incurred in other aspects of an investor’s portfolio. Results from research carried out by Ned Davis Research revealed that from 1972 through to June 2008, dividend-paying Standard & Poor stocks increase by 9.4 percent annually, as compared to non-dividend paying stock which rose by 1.8 percent for the same period. Investing in dividend-paying stock is not without risk however, as weaker companies facing financial difficulties may very well choose to cut the dividends paid out to investors. Nonetheless, taking all these factors into consideration, investment in dividend-paying stock is well worth considering.
