President Bush’s plan to end the so-called double taxation of dividends looks likely to encounter resistance when it reaches Congress, but the proposal could add momentum to an already growing corporate trend to distribute profits to shareholders through dividend payouts.
Essentially a portion of a company’s profits paid to shareholders on a quarterly or annual basis, dividends fell out of favor with investors in the 1990s, as growth stocks grabbed Wall Street’s attention.
Now, after three years of plunging stock prices, dividend stocks are making a comeback. Long-term investors are looking to invest in companies that offer more stable financial returns, and they are demanding that companies pay more of their annual profits to shareholders, a reaction to the poor fiscal management and corporate accounting scandals of 2002.
Boost for stock market
Under current tax law dividends are effectively taxed twice — once as corporate income and again when paid to company shareholders.
In his $674-billion tax package, announced in early January, President Bush called the shareholder taxation “unfair” and proposed its abolition. The thinking is the elimination of the tax will spur more investment, pushing the stock market up by as much as 10 percent and eventually promoting economic growth.
But the plan has its critics, most notably the Democrats, who counter that cutting dividend taxes would mostly benefit the very wealthy and won’t give the economy the short-term boost it needs. A number of senior Republicans have also expressed skepticism about the plan.
“It’s too soon for many companies to start paying dividends based on the Bush tax proposal,” said Arnold Kaufman, editor of Standard & Poor’s Outlook investment advisory newsletter. “But if it is enacted, or goes through in some modified form, it should get companies to pay dividends, or others to start increasing them.”
Corporate America was warming to the idea of dividends even before the Bush plan was floated.
The number of companies increasing their dividend payments to shareholders totaled 197 in January 2003, up 16 percent from on year earlier and at the highest level of any month since February 2000, according to S&P’s Kaufman.
Corporate dividend payouts declined 3.3 percent in 2001, the largest yearly drop since 1951, but they posted year-over-year increases in six out of seven months since July, Kaufman said, noting that October was the exception.
Last year saw a 2.1-percent increase in dividends paid by the companies in the S&P 500 index, the first year of growth since 1999. From 1928 to 2002, dividends for the index averaged a 4.7 percent rise.
Improvement in earnings
The primary reason for the rebound in dividends is an improvement in company earnings, which are showing signs of recovering after a dismal 2001, said Kaufman.
This growth is allowing companies to raise their dividend payouts, or start to offer them for the first time, Kaufman said, noting that in January 35 companies issued “extra” dividends, up from 19 in 2002. Companies that pay extra dividends are usually sharing robust earnings with their stockholders. “The trend is likely to continue,” he added.
Another Standard & Poor’s study shows stocks of companies that pay dividends have generally performed better than those of companies that don’t offer investors anything. Dividend payers in the S&P 500 averaged a decline of 13.5 percent in 2002, compared with a decline of 30.3 percent for non-dividend paying stocks, according to the study.
One of the companies raising its dividend in January was Bemis, a manufacturer of packaging products. The Minneapolis-based firm approved an 8 percent increase in its quarterly cash dividend, twice the size of its increases over the last several years. This year marks the twentieth year in a row that Bemis has increased its dividend payment.
“Three years ago analysts were telling us to get rid of our dividend and use the money to buy back stock,” said Melanie Miller, Bemis’ assistant treasurer. “At certain times that looks like a good idea, but right now dividends are paying a return to shareholders. They’re back in fashion, at least for now.”
Among the companies reporting dividend increases in January were well-known firms like Avon, Citigroup and Lehman Brothers. Also, in mid-January cash-rich Microsoft said it will pay shareholders an annual dividend for the first time. And Oracle, the world’s second-biggest software firm, said it would consider paying a regular dividend if taxes on such payouts were removed. (MSNBC is a Microsoft-NBC joint venture.)
Log considered growth companies, technology firms like Microsoft have traditionally held on to their cash reserves to invest in acquisitions and new technologies.
Other big technology firms are likely to follow suit, according to Kaufman, but smaller firms in the technology space are unlikely to issue dividends. “They don’t have much access to the credit markets, so they need a lot of their cash for share buybacks and reinvestment in their businesses.”
If President Bush’s dividend tax cut is endorsed in some shape or form, look for dividend payouts from financial services companies, drug makers and consumer stocks like retailers and food firms, Kaufman said.