Saturday, March 8, 2008

Why are Divident Paying companies better?

Many people who began investing during the tech craze of the 1990s were taught to ignore dividends. The logic was that company managers who couldn’t adequately reinvest in their own business for growth were probably a bad risk for any investment dollars.

Warren Buffett famously has never paid a dividend at Berkshire Hathaway because he wants to reinvest every dollar of free cash flow himself.

But neglecting dividend-paying companies hurts investor returns...

At the turn of the century, and with the change of tax treatment on dividends, money began pouring back into firms that paid dividends. (A prominent feature of the much-maligned Bush tax cuts included tax-code changes that dropped the rate for dividends from high ordinary income levels – 35% in the top bracket – to a maximum of 15%.)

Bernstein Global Wealth Management prepared the amazing chart below, which demonstrates the power of dividends over the long term.

The Bernstein study concluded, “It should therefore come as no surprise that dividends have been a major component of growth in an investor’s return over time. Remember, calculations of a stock’s performance in a portfolio are based on total return, i.e., the annual price appreciation (or loss) plus dividends.”

One dollar in 1926 (when market data first became reliable) invested in large-cap U.S. stocks would have grown to nearly $2,300 by 2004. But the Bernstein report shows that if you remove dividends – and the magical effect of compounding those dividends – then that same dollar would be worth a meager $87.66.

A similar study by Standard & Poor’s showed the same results over a different time horizon. The study of total returns (price appreciation plus dividend income) shows that payers of dividends outdistanced non-payers by 1.9% annually from 1980 through 2003.

Are there any attractive dividend payers right now? You bet…

3 Blue Chips With Mouth-Watering Yields

Because of the ugly stock market over the last few months, I see real opportunity in dividend-paying stocks. As investors have rushed to the safety of Treasuries, the yields on the notes have fallen. With 10-Year Treasuries yielding below 3.8%, it’s easy to find sound companies that have a higher yield.

I suggest researching some of the following blue chips for long-term income and capital appreciation:

AT&T (NYSE: T): This telecom giant is yielding a safe dividend of 4.1%, and it is seeing growth in both its wireless and broadband units. This growth will translate into share appreciation down the road.

Bristol Myers (NYSE: BMY): This pharmaceutical company’s prospects are looking up with a good pipeline of new drugs, and it pays an eye-popping 5.3% dividend. The last few years have been painful for BMY, but its restructuring has paid off.

Dow Chemical (NYSE: DOW) This diversified chemical company is a great bet on continued worldwide economic growth. Dow is well diversified across a number of industries, from plastics to agriculture. And it has geographic diversification, too. Plus, it pays a lip-smacking 4.3%.

Final point to remember: Consider buying high-yielding stocks in retirement accounts. That way you can improve the tax treatment on your dividends… and not have to worry about a tax bill until you begin to make withdrawals.

ere are some key terms to understand when investing in dividend-paying stocks:

Declaration Date: The date on which the board of directors of a company announces the amount of the next dividend and its ex-dividend, record and payment dates.

Ex-Dividend Date: The date on which, or after, the stock trades without a dividend. So if you buy the stock on or after the ex-dividend date, you will not receive the next dividend. If you sell a stock before the ex-dividend date, you will not receive the dividend (the buyer will receive the dividend). If you sell after the ex-dividend date, you will receive the dividend (the buyer will not).

Record Date: The date the company determines the list of shareholders who qualify for the dividend. To be a shareholder of record, you must own the stock at least one day before the ex-dividend date.

Payment Date: The date on which the dividend is paid to shareholders of record, in the form of a dividend check, or a credit to your account.

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