Dividends are the traditional way that stable companies with significant profits and cash share their income with stockholders.
Mutual funds loaded with dividend-paying stocks are more interesting to investors during periods when stock price appreciation seems less assured. These funds typically neither skyrocket nor crash, with their ongoing income helping to keep overall returns steady.
"Dividend income used to be a snoozer back when everything was growth-oriented," said Tom Roseen, senior research analyst with Lipper Inc. in Denver. "A lot of traditional fixed-income investors have now turned their attention to dividend-paying stocks."
The opportunity to benefit from both price appreciation and income distribution is attractive to many investors, Roseen said, especially retirees or Baby Boomers closing in on retirement. The government helped considerably in 2003 by reducing the maximum dividend tax rate to 15 percent, which will expire in 2010 unless it is extended.
A significant increase in the number of companies buying back their own shares--another way that firms tend to use cash--has been competing with dividend increases this year. Even so, the average dollar amount of dividend payouts is expected to increase by nearly 12 percent during 2007, according to Standard & Poor's Corp.
"To obtain the most yield, financial stocks represent a good sector, along with telecommunications, utilities and major pharmaceuticals," said Ralph Shive, portfolio manager of the $296 million First Source Monogram Income Equity Fund (FMIEX) for more than a decade. "My fund's yield would have been greater if I hadn't underweighted financials. I may be adding some financials in the next six months depending on how the [subprime lending] crisis shakes out."
As one of the top-performing dividend-focused funds, First Source Monogram Income Equity has a 12-month return of 22 percent and three-year annualized return of 18 percent. This "no-load" (no sales charge) fund requires a $1,000 minimum initial investment and has an annual expense ratio of 1.15 percent.
Among its largest holdings are AT&T Inc., Marathon Oil Corp., Alcoa Inc., General Electric Co., Emerson Electric Co. and Chevron Corp.
"The investor should always look for stocks or funds with steady records," Shive said. "We consider bigger, stable, steady companies that can raise their dividends every year to be the best places for investors to look."
An investor must look carefully at how steady the income distribution has been over the years rather than for just a short period of time, Roseen said. In the case of individual companies, past increases in their dividends should also be tracked.
"Over the long term, dividend-paying companies have done better and are less volatile than those that don't pay dividends," said Howard Silverblatt, senior index analyst with S&P in New York. "Since 1979 on the S&P 500, the dividend-paying stocks have done 2.19 percent better in annualized return than those that don't pay dividends."
Some noteworthy examples of dividend-oriented stock funds available to average investors:
-- The $265 million Amana Trust Income Fund, with 12-month return of 24 percent and three-year annualized return of 20 percent. This no-load fund requires a $250 minimum initial investment and has an annual expense ratio of 1.37 percent.
-- The $135 million Heritage Growth & Income Fund "A," with 12-month return of 26 percent and a three-year annualized return of 20 percent. It requires a 4.75 percent load, $1,000 minimum initial investment and has an annual expense ratio of 1.35 percent.
-- The $27 billion T. Rowe Price Equity Income Fund, with 12-month return of 15 percent and a three-year annualized return of 13 percent. This no-load fund requires a minimum initial investment of $2,500 and has a low annual expense ratio of 0.69 percent.
"Corporate ability to pay dividends is pretty good right now, and it is only through dividends that companies return cash to shareholders," Shive said. "I'm disappointed in some of the energy companies that haven't been more aggressive in sharing that with the shareholders."
Two of the current highest-dividend-paying stocks belong to telecommunications companies focused on rural markets, Silverblatt said. Both have a yield--or annual dividend divided by the stock price--of around 7 percent. They don't face the stiff competition they would encounter in urban markets, though future yields will inevitably be affected by changing markets and regulatory decisions.
The first, Citizens Communications Co., serves 2.5 million phone lines and 465,000 high-speed Internet access customers in 24 states, mostly in the eastern U.S. It is also actively buying back its own shares.
The second, Windstream Corp., serves 3.2 million phone lines, 2 million long-distance customers and 750,000 Internet customers in 16 states, primarily in the Southeast and Midwest. It was formed last year combining Alltel's former fixed-line business and Valor Communications.
Some financial firms with yields above 6 percent are First Horizon National Corp., Huntington Bancshares Inc., National City Corp. and Washington Mutual Inc., Silverblatt said.
"A lot of these issues are yielding more than the 10-year Treasury, especially if you adjust for taxes," Silverblatt said. "Treasuries are federally taxed at 35 percent and dividends only 15 percent, which is why more investors are considering dividend-paying stocks."
Andrew Leckey is a Tribune Media Services columnist.Copyright © 2015, CT Now