Hard Times Investing: Shareholders Count on Dividends More Than Ever

Buy, hold and rent is new strategy

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Companies hoarding cash since the start of the recession are beginning to pass on some of it to their shareholders in the form of increased dividends, but it's unlikely to match the boom of a decade ago.

Moody's Investors Service estimates that US nonfinancial corporations were sitting on $1.84 trillion in cash in the first quarter of this year—a 27-percent increase from early 2007.

"At some point, owners and shareholders are going to want management to put that cash to work," says Matthew Bristow managing director of ClearRidge Capital in Tulsa.

CFO magazine recently surveyed companies within its CFO Midcap 1500—those with $100 million to $1 billion in annual sales—and found they are holding, on average, 15 percent more cash this year than the same period two years ago.

Make no mistake, there was good reason for companies to amass cash at the outset of this recession. They saw bad times coming, with limited short-term growth prospects, and they expected to burn through that cash.

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Companies have begun to spread the wealth and are expected to continue to do so, by adopting or raising quarterly dividends, and in some cases, even paying a special, one-off, dividend.

Thus far this year, 15 percent of the companies in the Russell 3000 index raised their dividend payouts, double the number through the same period in 2009. That group includes blue chips such as IBM and General Electric , Philip Morris, Virgin Media andNews Corp are likely to soon join them.

Companies that have undetaken special dividends so far include Weyerhauser, Limited Brandsand Hot Topic .

"There has never been a better time to buy US large-cap, dividend-paying stocks," says Fred Taylor, principal of Northstar Investment Advisors . "For the first time since 1958, you can get more in dividend income—more than 3 percent—from great companies than from the ten-year U.S. Treasury note, which is now yielding less than 3 percent.

Taylor ticks off a list of household names, such as Coca-Cola , General Mills , Johnson & Johnson , Home Depot, McDonalds ,ADP ,Intel, DuPontand Waste Management .

"Stocks have a reasonable chance of appreciating or at least beating inflation at these levels once the economy recovers or we don't have a double-dip recession," says Taylor.

According to a study by National Data Research, dividend stocks outperformed the rest of the S&P 500by 2.5 percent annually over the last 36 years.

Wharton professor Jeremy Siegel looked at the S&P’s 100 highest-yielding stocks from 1957 to 2003 and found that they outperformed the market by an average of 3 percent. In a million-dollar portfolio, that's an extra $30,000 annually.

Even with predictions of slower economic growth ahead, dividend stocks should continue to provide rewards for investors.

"Investor rebates are likely to rise in value, as are substantial numbers of companies who modestly boost their dividends over the next 12 months," says Jeff Thredgold, chief economic consultant for ZionsBank in Salt Lake City.

One wildcard is tax policy, The Bush tax cut package, which includes capital gains and dividends, is set to expire at the end of the calendar year.

After its implementation some half dozen years ago, major companies rushed to take advantage of the reduction in rates from as high as 39 percent to 15 percent.

Companies such as Costco , Viacom, Best Buy and Staples began paying quarterly dividends for the first time.

Others, such as Bank of America ,Wal-Mart,PepsiCo and Home Depot ,make sizable increases.

Still others, notably Microsoft andMerck, paid enormous special dividends. The tech company paid out $3 a share, while the drugmaker's divident was a little less.

The question is now is whether the expected expiration will bring another windfall for shareholders. The Obama administration was initially expected to let all the tax cuts expire, but there's growing speculation—and hope—it might keep some of them in place.

The answer to that question may not be clear until around the time of the midterm elections. If repeal of the dividend tax cut is ervident, some companies will no doubt make a move. If not, they have reaons to stay on the sidelines, taking a wait-and-see approach.

Investors may want to temper their expectations just the same. Even under the best of tx conditions, the dividend boom of yesteryear is unlikely to be repeated.

"Dividend increases are likely to remain modest in years to come, as companies maintain higher levels of cash and cash equivalents to minimize exposure to another credit freeze and commercial paper market shutdown that scared many companies 18-24 months ago," said Jeff Thredgold, chief economic consultant for ZionsBank in Salt Lake City.

Citigroup was one the companies to boost its quarterlty dividend the most in the wake of the tax cuts, doubling it to 40 cents per common share a year by early 2004. At the time, that was $4.14 billion a year more in cash. By 2007 the dividend was up to 54 cents a share a quarter.

In January 2008, with the financial crisis beginning to rage, Citi had implemented the first of several cuts. A year later, after a government bailout, it was gone altogether.