The Number One Reason Dividend Stocks Aren’t Doomed

BRIC countries. Social media IPOs. And now dividend stocks?

Two weeks ago, at the 15th Annual Investment U Conference, I was asked if dividend stocks were the next investment craze destined to fade.

My response? Not a chance!

Admittedly, investor interest in dividend stocks keeps perking up. But that’s a by-product of artificially depressed interest rates. Not the sign of an investment bubble.

I mean, we’d be terrible stewards of our hard-earned capital if we just rolled over and accepted the going rates on certificates of deposit or U.S. Treasury bonds.

So it’s only natural for investors to be on an aggressive hunt for yield when the average money market pays next to nothing. Literally.

It’s true, too, that companies paid out a record amount in dividends last year. A total of $281.5 billion for S&P 500 companies, to be exact. And it’s impossible for companies to keep paying out record amounts every year for eternity.

But trust me. We’re nowhere near the end of the dividend bonanza. Here’s why…

~Reason #1: Payout Ratios Remain Low
As I’ve noted before, the percentage of profits that companies are paying out in dividends remains low.

The payout ratio for the S&P 500 Index currently checks in at 36%. While that’s up from 29% about two years ago, it’s still a country mile away from the long-term average of 50%, according to Standard & Poor’s head number cruncher, Howard Silverblatt.

In other words, companies can easily afford to keep paying dividends. Much higher ones, in fact.

And that’s exactly what’s happening. So far this year, 116 companies in the S&P 500 already increased their dividends.

~Reason #2: Cash Balances Remain High
In addition to an abundance of profits to pay for dividends, there’s a record amount of cash sitting on corporate balance sheets, too. Over $1 trillion, based on the most recent tally.

Apple (AAPL) serves as a classic example of what happens when companies sit on cash too long. Shareholders revolt! And they demand that the cash is paid out.

I’m willing to go out on a limb here and say that most companies don’t want to endure the public relations nightmare and distraction caused by such occurrences. So they’re more likely to pony up before any shareholders grumble.

Add it all up, and we could be in store for another flood of special dividend payments, as well.

~Reason #3: Corporate Insiders Like Getting Paid, Too
The No. 1 reason we’re not going to see a dip in dividend payments relates directly to greed. Or, if you prefer more politically correct terminology, it’s because humans are self-serving. All of us.

And as Morgan Stanley’s (MS) Adam Parker notes, the structure of corporate compensation packages hit a key milestone right before the financial crisis. Specifically, more CEOs now get paid with restricted stock grants than with options.


As Parker explains, “It is important that fundamental analysts understand how the senior management teams of the companies they are analyzing are variably compensated, as those with restricted stock and not options are much more likely to increase dividends. The principle? People rarely intentionally damage their own net worth.”

Bottom line: Unless you believe corporate insiders aren’t interested in enriching themselves, the dividend bonanza is going to continue.

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