Look beyond utilities for dividends
— -- Investors have had nothing but love for dividend-paying stocks. Love, love, love. And what's not to like? Dividends cushion your losses in downturns, augment your gains in bull markets and prove that a company is profitable.
As dividend-paying stocks have gained in popularity, however, haters have emerged. The main worry: Some dividend payers, such as utility stocks, are overpriced.
They have a point. But not all dividend-paying stocks are utilities. You can still find decent dividend payers. You just have to look further afield.
Most investors can agree that dividends — cash payouts to shareholders — are a wonderful thing. For one thing, a dividend shows that a company is profitable and thinks it will stay so for the long term. Wall Street crushes the stocks of companies that cut dividends, so boards of directors think long and hard before starting a dividend program or increasing the dividend.
Furthermore, a company can't say it's going to pay a dividend and not really do it, at least without fairly harsh market consequences. Stock buybacks, another common use of company earnings, are often announced, and often left undone.
And dividends are a valuable part of total return. The Standard & Poor's 500-stock index has gained 202% the past 20 years. Add in dividends, and the return grows to 350%.
Dividends were particularly prized last year. The reason: unmitigated terror caused by huge swings in the market. From 1950 through 2000, the S&P 500 had moves of 2% or more an average of five times a year, says Sam Stovall, strategist for S&P Capital IQ. From 2000 through 2010, the average was 15. Last year? 21.
Investors also are getting older. "When people are afraid and old, they want more of their total return from income," says Laton Spahr, manager of Columbia Dividend Opportunity fund.
Electric utility stocks were born to be mild: They have predictable earnings, low volatility and consistent dividends. Last year, electric utility stocks gained almost 20%, including reinvested dividends, vs. virtually nothing for the S&P 500. No wonder investors showered utilities with love.
Perhaps a bit too much love. Normally, utilities stocks have a price-to-earnings ratio of 26% less than the S&P 500, Stovall says. (The P-E ratio — price divided by earnings per share — is an indication of how expensive a stock is, relative to earnings. Lower is cheaper.)
Today, utilities stocks sport a 14.2 P-E, vs. 12 for the S&P 500. And S&P estimates that utilities' earnings will fall 2% next year, Stovall says.
But you can find dividends pretty much everywhere, says Spahr. Large technology companies, such as Microsoft, Intel and Oracle, all now pay dividends. "They're huge, entrenched, cash-cow businesses," he says. They have lots of free cash and not enough opportunities to spend it — so they're giving it to their investors.
Financial services companies are another area for more daring investors, Spahr says. Most big banks are building capital as a cushion against losses. Once they become healthy again, banks could once again be reliable dividend payers.
