U.S. shareholders are seeing companies boost dividends again, after two years of sharp declines in payouts. However, at the same time, taxes on their dividends could be heading higher, taking a bite out of shareholders' income and potentially hurting the performance of dividend-paying stocks.
So far in 2010, 10 companies in the large-cap Standard & Poor's 500-stock index that hadn't been paying dividends started doing so, according to Standard & Poor's. Another 146 increased their quarterly payout. Just one company—Valero Energy (VLO)—has lowered its dividend, and another, refiner Tesoro (TSO), canceled it altogether.
Taxes on these dividends could be rising because, at the end of 2010, tax cuts implemented under former President George W. Bush automatically expire. The federal tax on dividends is now capped at 15 percent but, unless Congress extends the Bush cuts, the highest rate could jump to 39.6 percent.
The short-term effect of a higher dividend tax could be significant, particularly for stocks with generous payouts. "The higher the yield, the more negative impact there could be," says Henry Sanders, portfolio manager of the Aston/River Road Dividend All Cap Value Fund (ARDEX).
Dividends can be an important source of an investor's total return. According to Standard & Poor's, dividends have contributed 45 percent of the total return of the S&P 500 since 1928.
Over the long term, "dividend-paying stocks tend to outperform non-dividend-paying stocks and tend to do so with less risk," Sanders says. Their appeal is enhanced at a time when other investments, like bonds, are providing historically low yields. "Right now people are desperate for income," Sanders says.
In July, Walgreen (WAG) hiked its dividend 27.3 percent, General Electric's (GE) dividend rose 20 percent, and manufacturer Cummins (CMI) hiked its dividend 50 percent. Starbucks (SBUX) raised its dividend 30 percent in July, just one quarter after paying the company's first dividend ever. Founder and Chief Executive Officer Howard Schultz told analysts July 21 the increase was a sign "the board has confidence in the financial performance of the company and the amount of cash that we generate."
"We've had companies bump up their dividends as management teams gain confidence in the outlook," says John Buckingham, chief investment officer at Al Frank Asset Management.
Expect the dividend increases to continue. Bloomberg analysts use criteria such as options, company guidance, and industry analysis to forecast dividends. In the third quarter of 2010, which ends Sept. 30, another 20 companies in the S&P 500 are forecasted to increase dividends. Analysts estimate the three largest increases of the rest of the quarter will come from: Pioneer Natural Resources (PXD), with an estimated 50 percent increase; News Corp. (NWSA), with an estimated 20 percent increase; and Microsoft (MSFT), with an estimated 15.4 percent hike.
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