Dividend-paying stocks making a comeback

Dividend-paying equities can be a great choice for long-term investors willing to forgo immediate returns in favour of substantial returns later. Once denigrated as the province of widows and orphans, dividend-paying stocks are being seen in a new light by investors who have weathered the highly volatile stock market of the past decade.

Turning to dividend-paying stocks during times of economic uncertainty is not a new concept. However, it’s one that seems especially relevant now, with the dividend yields of many stocks providing a relatively attractive alternative to the historically low yields delivered by bonds. While Canadian dividends are subject to preferential tax treatment, American dividend-paying stocks are also noteworthy given the current yield environment.

Compelling yields

Many stocks today offer compelling dividend yields relative to Treasuries—some say they provide the best advantage since the 1950s. In fact, as of September 30, 2010, the S&P 500 dividend yield is 2.03%, with the 3-month T-bill yielding 0.16%, 2-year T-notes yielding 0.42% and 5-year T-notes yielding 1.27%. What’s more, cash on corporate balance sheets is at unusually high levels. In other words, many companies are in a position to increase dividend payouts and respond to rising growth opportunities.

Companies with a long history of growing dividends have produced a favourable risk/reward profile over time, holding up better on the downside and producing better results on the upside. For example, the S&P 500 Dividend Aristocrats Index (companies in the S&P 500 Index that have increased dividend payout for at least 25 consecutive years) has provided higher returns with less risk than the S&P 500.

The benefits Dividend-paying stocks offer many potential benefits for investors:

• A sign of quality: Consistent dividend growth can confirm a firm’s quality, as it shows the company’s ability to consistently increase cash flow over time. Many companies are currently in their best financial shape in decades; several companies have raised their dividends, some sharply. Coming out of the worst recession of our lives, we cannot help but believe these high-quality companies offer the best values in the financial spectrum.