The Importance of Dividends

The current dividend yield on the S & P 500 index is about 2%. According to a recent article in Barrons’, dividends accounted for 43% of stock market returns over the past 83 years. The remaining return came from the change in stock prices. So far in 2009, dividends have accounted for only about 10% of the market’s total return.

We believe that dividends help put a floor under the value of a stock, because you are receiving an ongoing stream of cash flows from the time that you make your investment. Growth stocks, which pay lower or no dividends, must earn their total return exclusively from the change in price.

It is important to consider both the level and sustainability of dividends. The S & P 500 has a payout ratio of about 45%. This means that for every $1.00 in earnings, companies are paying an average of about $0.45 in dividends. Significant levels of debt or off-balance sheet obligations like under funded pension plans or post-retirement health care benefits may restrict a company’s ability to pay dividends in the future, since they have other needs for this cash. When evaluating individual stocks for inclusion in client portfolios, our Investment Policy Committee considers both the current dividend yield and the payout ratio. A high payout ratio of 75% or more may indicate that the dividend is at risk of being cut in the future. An unusually high dividend yield is also a sign that the dividend may not be sustainable. If something seems too good to be true, it usually is.

Why not buy all dividend paying stocks? Different clients with different investment objectives may have different levels of dividend paying stocks. A retiree who is spending from their portfolio, in addition to possibly having an allocation to fixed income (bonds), may have more dividend paying stocks than a younger client in the accumulation phase. Increasing portfolio income is one factor that we take into consideration as we review client portfolios for potential improvements. Also, a cornerstone to our investment philosophy is broad diversification including growth and value companies, small, medium and large companies and international companies. We never know for sure what is going to do better, so we want to have a mix of assets that will perform well under a variety of market conditions. If we focused exclusively on dividend-paying stocks, we would be forced to underweight sectors of the economy like technology that we believe have attractive future growth prospects. This year, large growth companies have returned over 32% versus 17% for large value companies. Small and mid-sized growth companies have also outperformed their value counterparts during this period. Therefore, including an allocation to growth companies that pay little or no dividends has helped portfolio returns this year.

Currently, dividends are taxed at the same rate as long-term capital gains. With the Bush tax cuts currently set to expire at the end of 2010, dividends are scheduled to be taxed at higher ordinary income rates for 2011 and beyond. The main implication of this from an investment perspective is asset location. If the tax on dividends does rise, we would lean towards putting higher-dividend stocks in a tax-deferred account such as an IRA where feasible.

Bill Hansen, CFA
November 25, 2009

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ORGANIZE! ORGANIZE! ORGANIZE!

Are your affairs in order if you died tomorrow? Is your will or trust up-to-date? Do you have the assorted legal documents all in place: healthcare power of attorney, durable power of attorney? Have you checked the beneficiaries on your retirement accounts lately? Be Prepared – isn’t that the Boy Scout motto? We have seen clients with five or six separate IRA accounts or brokerage accounts at various places. Combining like-type accounts is much simpler and certainly less paperwork. Do you have old stock certificates lying around? If you would deposit them now into your brokerage account you will save your beneficiaries much time and trouble. Do you have a safe deposit box? We have seen clients that have had multiple bank accounts and more than one safe deposit box. Your beneficiaries need to know where to find the paperwork that leads them to your various accounts, certificates and safe deposit boxes. I recently had a client die and his daughter found a notebook in his residence with detailed instructions on where everything was, including a map of downtown Asheville with instructions on how to find Parsec Financial. You might also consider checking on your parent’s situation (if they would permit that).

Barbara Gray, CFP®
Partner

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Who Says it isn’t Easy Being Green?

Well, I finally broke down and invested in a socially responsible mutual fund. I don’t know what’s happening to me – I’m starting to have feelings, a conscience – and I was so convinced that I’m perfectly logical. I blame it on becoming a parent. I’m suddenly much more concerned about how companies are making profits, rather than just if they are. And apparently, I’m not the only one – socially responsible investing (or SRI) has been around for over 250 years, beginning with early religious proponents such as the Society of Friends (a.k.a., Quakers) and John Wesley. Though the objectives of some socially responsible mutual funds are still rooted in religious principles, most are now concerned primarily with environmental sustainability and corporate governance. A mutual fund (or fund company) with socially responsible objectives screens its investments both for elements it doesn’t want (business practices that are harmful to individuals or the environment) and for elements it does (clean technologies, ethical business practices, respect for human rights).

Finding out the objectives of a particular socially responsible fund is a relatively simple matter of searching for the fund company online – they usually list that sort of information on their website. (Well, I say simple, though recently my computer was infected with a virus that attacked my search engine of choice. I noticed something was amiss when Google was all dressed up for Thanksgiving – on October 12th. After glancing at my calendar to make sure it wasn’t already the fourth Thursday in November, I saw it was Thanksgiving – in Canada! The virus was redirecting me to Google Canada, for some reason, as well as to malware-loaded sites, but our IT folks got me all cleaned up.)

In this article I’ve focused mainly on mutual funds, because with individual stocks, it’s easier to pick and choose the companies in which you’d like to invest. When you buy shares of a fund, though, you are buying a basket (sometimes hundreds) of individual companies, and it’s hard to know what you own, since you are in effect paying the fund manager to choose the investments for you. However, you can find a socially responsible fund that screens companies for the qualitative measures that are important to you, a process for which they are much better equipped than the typical individual investor. And, with SRI accounting for about 11% of the US investment marketplace (according to socialinvest.org), it’s getting easier to find funds with good track records and reasonable expenses. 

So, what’s the main takeaway here? That apparently, Canadians celebrate Thanksgiving, too. Not that there’s anything wrong with that, eh?

Sarah DerGarabedian

Research and Trading Associate

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