Wall Street Journal (October 15, 2003)
By JONATHAN CLEMENTS
Stocks Are the New Bonds: Yields Are Becoming
Cash is back.
Sure, this year's stock-market
rally has been heartening, especially after
three losing years. But what really excites
me is the renewed focus on dividends.
Not only have dividends contributed
almost half of the stock market's long-run total
return, but also they have provided investors
with a remarkably reliable stream of income.
In fact, a good case can be made that stocks
are a better source of income than bonds.
Squandering Cash: Buy stocks for
income? Only a few years ago, investors would
have scoffed at the idea. In the growth-obsessed
1990s, shareholders were happy to see companies
reinvest corporate earnings, in the hope this
would lead to even fatter profits down the road.
But as we have since discovered,
a lot of this corporate cash got squandered
on foolish efforts at faster growth and obscene
paychecks for top executives. Now, companies
are out to regain the trust of investors, by
initiating dividends and increasing payouts.
"It's the old saying: money
talks," says Howard Silverblatt, an equity
analyst with Standard & Poor's, a unit of
McGraw-Hill. "It's a way for companies
to send a signal to the market."
The turnaround has been remarkable.
Over the five years through 2002, dividends
paid by the companies in the Standard &
Poor's 500-stock index grew at just 0.8% a year.
But S&P estimates that dividends
will rise 4.5% this year and 10.1% next year.
And there's plenty of room for further increases.
This year, S&P 500 companies are expected
to pay out 38% of their earnings as dividends,
far below the historical average of 54%. The
push to pay bigger dividends has also been encouraged
by this year's tax law. Dividends, which used
to be taxed as income, are now dunned at a maximum
rate of 15%. That's the same as the long-term
capital-gains rate and less than half the maximum
income-tax rate of 35%.
Yielding to Reason: I would like
to see companies continue to boost dividends
until they once again top 50% of earnings. How
come? Unfortunately, management has proved to
be a lousy steward of shareholders' capital.
Assuming this year's profits come
in as expected, earnings per share for the past
50 years will have climbed at just 5.9% a year,
slower than the economy's 7% growth rate. Clearly,
many companies should give up gunning for growth
and instead pay fatter dividends. Shareholders
could then decide how to invest the money or
whether they want to spend it.
Which brings me to the notion
of buying stocks for income. Years ago, a money
manager named Steven Somes (who, sadly, has
since died) told me that, as a retiree, you
would be in great shape if you could simply
live off the dividends from your stock portfolio.
Indeed, over the 50 years
through 2003, dividends have provided
income-hungry investors with a wonderful
stream of cash that has grown at 5% a
year, comfortably ahead of the 3.9% inflation
rate. Moreover, those dividend increases
have been delivered with remarkable regularity,
rising in 45 of the past 50 years. By
contrast, clocking capital gains has been
an iffy proposition. Assuming 2003 finishes
as an up year, share prices will have
posted gains in just 36 of the past 50
Problem is, if you buy the S&P 500
today, you will get an initial dividend
yield of just 1.6%, versus 4.3% for 10-year
Treasury notes. Nonetheless, buying stocks
for income isn't quite as absurd as it
Suppose you purchase the S&P 500
and dividends continue to rise at 5% a
year. If you spent yourdividends but didn't
sell any shares, the yield on your original
cost would climb to 4.3% after 20 years,
matching the yield on today's 10-year
The wait would be even shorter, if you
factor in taxes. Let's say you are investing
through a taxable account and you are
in the top federal income-tax bracket,
with your dividends dunned at 15% and
interest at 35%. If tax rates stay at
current levels and your dividends grow
at 5% a year, it would take 15 years for
your after-tax dividend income to match
the afte rtax yield on a 4.3% bond.
Embracing Dividends: Despite this
year's tax cut, dividend-paying stocks have
been laggards in this year's boisterous market
"It's a bit ironic, but it's
not that big of a surprise," says Tom Huber,
manager of T. Rowe Price Dividend Growth Fund.
"In the early stages of an economic recovery,
it's not unusual to see lower-quality, nondividend-paying
stocks do well. I think it's a great time to
look at dividend payers. The valuations lookreasonable
relative to the rest of the market."
Updated October 15, 2003
ABOUT THE AUTHOR
Jonathan Clements has written
The Wall Street Journal's Getting Going personal-finance
column since October 1994. Born in London, Jonathan
is a graduate of Emmanuel College, Cambridge
University, where he edited the student newspaper.
He was a writer and researcher for Euromoney
magazine in London before moving to the New
York area in 1986. Prior to joining the Journal
in January 1990, he covered mutual funds for
Jonathan is the author of "You've
Lost It, Now What? How to Beat the Bear Market
and Still Retire on Time," published in
2003. His earlier books include "25 Myths
You've Got to Avoid -- If You Want to Manage
Your Money Right" and "Funding Your
Future: The Only Guide to Mutual Funds You'll
Ever Need." He has two children and lives
in Metuchen, N.J.