Wall Street Journal (October 15, 2003)

Getting Going
By JONATHAN CLEMENTS

Why Stocks Are the New Bonds: Yields Are Becoming Attractive

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 years. 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 seems. 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 Treasurys. 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 rally.

"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 Forbes magazine.

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.