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Published: 5/28/2002

Despite vanishing dividend, many investors are transfixed by yields

Despite a decline in dividend yields in recent decades, millions of long-term investors still consider dividends before they buy a stock.

Perhaps that's why a number of firms recently boosted dividends - even during a time of slumping profits and shaky economic forecasts. Among them: SBC Communications, IBM, and Pepsico.

But at the same time, many companies have eliminated or cut dividends. Dividend yields have dropped sharply in the last decade, the Federal Reserve Bank of Cleveland reported in a recent Economic Commentary newsletter - and yields now stand at about 11/4 percent, nearly a record low.

How important are dividends? Very important to investors with a historical outlook and a buy-and-hold philosophy. Not important to investors who want the companies to plow earnings back into growth opportunities, or the buy-and-trade variety of investors.

Stock-market history shows why many investors love dividends. Each $1 invested in large-company stocks at the end of 1925 grew to $2,279 by the end of last year if all dividends were reinvested, according to Ibbotson Associates, a Chicago firm that tracks investment performance.

But if dividends had not been reinvested, that $1 worth of stock would have grown to just $90 in the 76-year period.

In that stretch of time - three-quarters of a century - dividend yields averaged 4.4 percent. In other words, stockholders were getting not only price appreciation but also the equivalent of an extra 4.4 percent a year in “interest.”

Many investors use dividends as the core of their portfolio strategy. For example, there are the fans of the “dogs of the Dow” scheme. They buy five to 10 of the 30 stocks making up the Dow Jones industrial average - the ones offering the highest yield (annual dividend divided by stock price). Those stocks are “dogs” because they have low price-earnings ratios, and, of course the hot stocks always have high PEs.

With few exceptions, that strategy has done better than the major indexes over the last 20 years or so, presumably because they're large, good companies that have the financial muscle to survive even the toughest of times.

John Carlson, an economic adviser at the Cleveland Fed, offered several reasons for the slippage in yields. Stock prices are relatively higher than they were in most of the last century. The recent decline is perhaps a continuation of a long-term trend - yields averaged 5.3 percent from 1871-1945, but averaged 4.1 percent from 1946-2000. And stock buybacks have become a popular substitute for dividends.

By the late 1990s, share repurchases by corporations outpaced dividend payments. The theory is that buying back stock increases value for the remaining outstanding shares.

The trend toward lower yields could be good for some investors, bad for others.

Mr. Carlson said in the Fed newsletter that after World War II many companies chose to retain a greater share of earnings to reinvest in future growth. “The decline in the dividend yield was more than offset by increased growth in earnings per share,” he wrote.

But, given what has happened on Wall Street in the last few years, a $90 return on a $1 investment is starting to look very good. Forget the $2,279.



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