Quality Flight Gains Height

Dividends are back in vogue in a big way. Wall Street observers point to several factors contributing to this 180-degree shift — Baby Boomers facing retirement, more favorable tax treatment of dividend income, and a general flight to quality in the equities market. Today a number of closely watched benchmarks rank dividend-paying stocks, and a host of new funds are raking in investment dollars by focusing on dividend income.

The “bird in the hand” principle may also be at work. Dividends typically contribute 30 to 40 percent of the total return of the broad-based market indexes. And, unlike share price appreciation potential, that’s money you can take to the bank.

Ranking the AchieversMergent’s Dividend Achievers Index has tracked the performance of dividend-paying companies since 1979. Making the cut is no small feat, according to Mergent President Robert Andrialis. “To be recognized as a Dividend Achiever, a company must have 10 consecutive years of increasing dividends — and at the same time meet certain size and liquidity requirements,” he says. Of the thousands of publicly traded, dividend-paying U.S. companies, only a small fraction of firms make the grade. “Those companies that become Dividend Achievers — the current list is 330 –are companies that, at a minimum, have had increases of 10 years or more and are sizeable firms based upon their trading volume,” says Andrialis.

Moreover, he notes, Dividend Achievers boast strong cash reserves, solid balance sheets and a track record of consistent earnings growth. In other words, they are healthy, well-run enterprises. Some of the original constituents of the first index, started back in 1979, are still in it today, including such household names as Bank of America, American International Group, PepsiCo and Johnson & Johnson.

Mergent’s focus on consistent dividend growth sets its index apart from others, according to Andrialis. “We divide the world into two camps: dividend-paying indexes and dividend-growth indexes. Most of the indexes out there are dividend-paying indexes.” Consistent dividend growth is the best gauge of a company’s management and strategy, he adds. “We believe that consistent dividend-growth, as opposed to merely dividend-paying stocks, indicates top-quality companies.”

Feeding investors’ appetite for dividend income, several high-profile asset managers have introduced investments based on Mergent’s Dividend Achievers Index. Chief among these are PowerShares, which offers five Dividend Achievers ETFs; BlackRock, which sells four Dividend Achievers Trusts; and mutual fund giant Vanguard, which markets two funds based on the Dividend Achievers Index. The index is also used by such investment management powerhouses as UBS and the National Bank of Canada.

The index is revised annually, with companies that fail to meet the criteria deleted and new dividend-paying companies added. In 2007, 35 new Dividend Achievers were added to the index, an indication of the growing popularity of dividends, while 21 were removed. Of the latter, about half dropped off the index because they were acquired by other companies.

Less Taxing Returns The tax reduction act of 2003 made dividends more attractive by slashing the maximum federal tax rate on dividend income from as much as 36.8 percent to 15 percent. “It’s not a coincidence that dividend investing came back into vogue at the same time that the Congress eliminated the double taxation on dividends,” Andrialis says. This provision is scheduled to sunset in 2010, but many observers believe it’s likely to be extended.

“As you go through life, you have different tolerances for risk. Certainly as you get closer to retirement, a steady stream of income — plus the added return of price appreciation–is more attractive,” explains Andrialis. Regular dividend growth also provides a hedge against inflation, since steadily increasing dividend income can help offset rising cost of living. That’s another big plus for retirement investors.

Finally, the long-term, risk-adjusted performance of Dividend Achievers, measured by total return to shareholders, tops other broad market indexes. As Andrialis notes, “Those companies that pay dividends — and particularly increasing dividends over a long period of time — go a long way to showing what their growth formula is. When you do statistical analysis on the Dividend Achievers, compared to the S&P 500, you get higher returns with lower volatility. That is, you get better growth at lower risk.”

Growth and IncomeEnergy and infrastructure leader MDU Resources, headquartered in Bismarck, N.D., ranks high on the list of Dividend Achievers.