Your Money: Taking stock in dividends
By Juergen Selk
By Juergen Selk
Taking stock in dividends
In an environment in which EPS growth may be more difficult to come by, dividend yield becomes a more important component of future total return expectations for stock investors.
With lower yields on short-term money market instruments, and the yield on the S & P 500 at record lows, investors looking for attractive dividend payers must include some stock yielding 2 percent to 3 percent in their search.
There are still a number of attractive stocks that yield more than the S & P 500 and also have above-average dividend growth prospects. Moreover, we project moderate dividend growth for the S & P 500 over the next five years.
The Power of Dividends
To appreciate the power of dividends, consider the historical total return of common stocks over a long period. If you had invested $1 in the S & P 500 at the end of 1925, and reinvested all of the dividends, that $1 would have grown to about $2,350 by the end of 1998.* If we break down the results, we discover that the appreciation of the original $1 invested was about $96. The remaining $2,254, or about 96 percent, came from reinvesting the dividends and the capital gains on the shares bought with those reinvested dividends. For every dollar of return generated by capital gain on the original $1, the effect of compounding and reinvesting of dividends generated almost $24.
The Tax Perspective
With the enactment of the Taxpayer Relief Act of 1997, there is a material difference in taxes paid on long-term capital gains compared with ordinary (and dividend) income for many investors. For growth and income investors, it will be important to seek out stocks that provide some yield, but are also expected to grow their dividends at above-average rates. Take a hypothetical stock yielding 2.5 percent for which the dividend is projected to grow by 10 percent a year over the next five years. If, five years out, this stock is yielding 2.5 percentthe same yield as todaythen an investor could receive a total return of 12.5 percent on a yearly basis average with dividends and before taxes. In a gradually rising stock market environment, the reinvestment of dividends could result in the compounding of this return. Importantly, a meaningful component of the return would be in the form of capital gains.
Juergen Selk is a financial consultant at Salomon Smith Barney in Rockford. Salomon Smith Barney does not offer tax or legal advice. If you have an investment or finance-related question, send it to The Rock River Times or to Juergen.Selk@rssmb.com!