By JACK HOUGH
Expect more cases like these. "Companies are increasingly aware of the premium investors are willing to pay for current income in a yield-challenged world," wrote Jim Morrow, manager of the Fidelity Equity Income fund (FEQIX), in a recent email exchange.
Dividends were a bright spot in an otherwise gloomy market last year. The S&P 500-stock index returned 2.1% including dividends, versus an average over the prior half-century of close to 10%. But a simple strategy of selecting the 50 highest-yielding shares in the S&P 500 returned 18.5% last year, according to Savita Subramanian, a stock strategist with Bank of America Merrill Lynch.
The retirement of the baby boomers, who began turning 65 last year, is likely to increase demand for dividend-paying stocks in coming years, according to Ms. Subramanian.
So which companies among those that don't pay dividends today might soon begin paying them, possibly giving their share prices a boost?
Identifying companies that should pay dividends is the easy part. Any company that consistently generates more cash than it needs for day-to-day expenses is a candidate. Among S&P 500 firms, last year saw 22 payment initiations, the most in more than a decade. But 106 of the 500 index members still pay nothing, and record cash balances suggest some of these companies will announce new dividends this year.
Sorting companies that will pay from those that merely should is more difficult. If Cisco and Amgen are any indication, poor past stock performance is a good predictor. Perhaps shareholder patience with non-payers runs out when their stock prices stop rising.
I ran a recent screen for companies that sit on excess cash today and generate yearly free cash from operations equal to at least 5% of their stock market values -- enough to easily support a 1% to 2% dividend yield. That turned up companies like Apple (AAPL)
Of course, these and other companies may view share repurchases as a better way to return cash to shareholders. Repurchases reduce the number of shares outstanding, thereby increasing earnings per share and, theoretically at least, making shares more valuable. One clear advantage of repurchases is that they don't trigger investor taxes, while dividends generally do.
But dividend rates are typically set ahead of time, and repurchase rates are not. For companies, that's a lure to spend the most on shares in years when profits are fat -- and share prices, accordingly, are high. The financial crisis of 2008 and 2009 demonstrated that when the market plunges, most companies continue paying their dividends, but nearly all stop buying back stock. Ultimately, the choice may come down to investor preference. If dividend-paying shares continue soaring, more companies will want to pay.
Of course, all of this hinges on what happens next with dividend taxes. The dividend tax rate for U.S. investors is currently capped at 15%, but the cap is set to expire at the end of this year. Without an extension, next year's dividend tax rates will range from 15% to over 39%. A higher rate would surely dampen investors' recent enthusiasm for dividends, and possibly hurt the share prices of big payers. A long-term extension of low rates, however, could convince more companies to pay.