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A Realistic Look At A Hot Topic: Dividend Stocks

Wall Street pundits are lining up to tout the prospects for dividend-paying stocks in 2013, but prudent investors need to understand the bigger picture before rushing into this hot area of the market.
It’s true that dividend-paying stocks made a solid comeback in 2012 and offer good prospects for 2013, but it’s important to keep this trend in perspective.  The percentage of profits paid out by companies in the form of dividends remains far below historical averages, and an economic downturn could prompt U.S. firms to pull back on dividends again at any time.
As an investor, you also need to consider dividend stocks relative to other income-producing investments, in the context of a low-interest environment and your own portfolio.  Because no one can say for sure which investments will outperform others, it’s important to strike a prudent balance among possible choices.

A number of analysts believe dividend-paying stocks will produce solid returns this year for several reasons, starting with the fact that many large companies have built up huge cash reserves as they proceeded cautiously through the wreckage of the 2008 fiscal crisis.  “While companies are paying out record dividends, these amounts are still significantly below historical payout rates,” wrote Standard & Poor’s analyst Howard Silverblatt in the firm’s annual dividend report in January.  “It’s not a matter of companies being cheap.  It’s a matter of them being nervous about the economy and their resources, similar to most of us.”

Companies in the S&P 500 index paid out a record $281.5 billion in dividends in 2012, 17% more than in 2011.  Yet the payout ratio—the percentage of profits that companies devoted to dividends—was just 36%, far below the historical average of 52%.

That leaves companies with a lot of room to increase dividend payments, according to Silverblatt, who predicted another record for regular cash dividends in 2013.  “The 2.8% overall equity yield remains relatively high, even at the higher dividend tax rate (now 20% for certain upper income investors), when compared to competing income producers such as corporate bonds, Treasuries, or bank CDs,” Silverblatt wrote in the report.  “Given the range of yields within equities, from lower yielding growth issues to higher yielding income producers, this leaves investors with one of the few remaining areas of choice with measurable degrees of stability.”

Still, the potential for the economy to turn downward dictates continued caution for investors. It doesn’t take much of a decrease in stock prices to more than offset whatever income you derive from dividends.  In any event, dividend-paying stocks may play a positive role as part of a well-balanced portfolio tailored to your individual goals.

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