Heard on the Street

Investors, Dividends
Rediscover the Love

By GREGORY ZUCKERMAN
Staff Reporter of THE WALL STREET JOURNAL

Paying dividends is starting to pay dividends.

For much of the past year-and-a-half, investors ignored stocks paying healthy dividends. Keep your dividends, the investors seemed to say, we would rather take our chances on capital gains from rising prices. Even after taxes on dividends were slashed last year, most investors shrugged.

But there has been a change of heart in the past few months. Since February, companies paying dividends have done somewhat better than stocks that don't make such payouts. Now some analysts are starting to recommend that investors focus on stocks such as American Express, Chubb, Exxon Mobil, Viacom and Lockheed Martin that could boost their dividends in the months ahead. Other investors are searching for companies that might institute dividends for the first time, such as Yum Brands.

"The quality trade -- dividend payers with stable earnings and strong cash flows -- will be the way to play 2004," says Jason Trennert, strategist at International Strategy & Investment, a New York research firm. "As we've gone through tax season," dividend stocks have begun to be appreciated by investors. That trend likely will continue, some analysts predict.

Dividend-paying stocks aren't exactly flying off the shelves. Stocks in the Standard & Poor's 500 making such payouts are flat since February, while those in the index that don't pay dividends are down a bit more than 1%, according to ISI's research. And in the past few weeks companies holding off on dividends have done a bit better again, partly because the bond market's tumble has sent bond yields higher, making them more competitive with stock dividends.

In fact, many companies continue to prefer buying back shares with their extra cash, rather than start paying out dividends, despite last year's move to cut taxes on dividends.

But some say dividend-paying stocks, and those likely to begin paying out dividends, increasingly will be in demand as the year progresses -- and during the next few years.

Behind the bullishness is a view that price/earnings multiples on most stocks already are stretched, so it will be hard for many stocks to climb unless recent sharp earnings growth can continue. At the same time, last year's tax change, which cut dividend-tax rates for most investors, has made dividends more attractive. The top federal income-tax rate on most corporate dividends now is 15%, compared with rates as high as 38.6% in 2002.

Some say companies paying dividends are more valuable as interest rates rise, as they have lately. While rising rates make bonds more competitive with the still-skimpy dividends of most stocks, higher interest rates also make it more difficult for many highly leveraged and growing companies, putting a damper on riskier stocks and steering more investors to the safety of stocks paying dividends.

Rather than simply focusing on stocks paying high dividends, some analysts say the smarter move is to target stocks likely to boost dividends or begin paying them. Higher dividends likely won't mean much of windfall for investors, and there is some evidence that high-dividend stocks underperform for long stretches of time. But when a company raises its dividend, or begins making dividend payments, it can be a sure sign of the long-term health of these companies, some analysts say.

"Dividends are nice to have, but for me it's a question of the strength of the underlying company, dividends are more important as a signal," says Abby Joseph Cohen, Goldman Sachs's global strategist. "Shareholders are looking for some affirmation that companies feel good about the future" and raising dividends are a "powerful signal," says Ms. Cohen.

Academic studies lend some backing to this view. A recent paper by Prof. Alon Brav of Duke University, along with professors John Graham, Campbell Harvey and Roni Michaely, surveyed almost 400 executives and found that they view dividend payouts as a step that conveys "management's confidence about the future." Since executives are reluctant to cut dividends, they only raise them after becoming more upbeat about the outlook for their companies.

In addition to American Express, Exxon Mobil and Viacom, Goldman Sachs analysts point to Sunoco and United Technologies as two other stocks that are producing so much cash flow and earnings that they may soon announce higher dividends. ISI's team of analysts point to PepsiCo, 3M, Viacom and Clear Channel Communications as companies that could raise dividend payouts. Other speculate that Microsoft could boost its recently announced payout.

"Strong earnings and cash flows in 2003 set the stage for large dividend increases in 2004," predicts Michael Clement, a Goldman analyst. "Dividend increases usually lag improvements in cash flows, as companies are reluctant to raise dividends at the first signs of expansion."

One catch: Most dividend moves are done in the first and second quarters of the year, as companies try to court investors around the time of an annual meeting. "By late spring or early summer this theme will be much less interesting," Goldman's Ms. Cohen says.

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com