3 Reasons To Keep Banking On Dividends

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 |  Includes: MCD, MSFT
by: Dividends & Income Daily

Leave it to the politicians to try to spoil our fun.

Thanks to the ongoing government shutdown, investor interest in dividend stocks is rising. This is a natural and totally predictable reaction. Kind of like when lousy techno music starts playing and all the kids from the Jersey Shore instantly break out the fist pumps.

You see, when things get uncertain in the market, investors always flock to safety and certainty.

And that's precisely what high-quality, dividend-paying stocks offer - safe, certain income. Or, as Barron's Shirley A. Lazo puts it, "Dividends remain a refreshing respite."

You don't have to tell us, though. We've been basking in the refreshing glow of steady (and increasing) dividend payments for years now.

So the issue at hand now is this: Do all the Johnny-come-lately investors signal the end of the dividend trade? Is the "dividend bubble" about to burst?

Let's go to the data to find out…

In Record Territory

At first blush, the latest dividend stats certainly suggest excess. Consider:

  • Almost 85% of the companies in the S&P 500 Index now pay a dividend. That's a 15-year high.
  • Total cash payouts by U.S. companies surged more than 14% in the third quarter, according to Howard Silverblatt, Senior Index Analyst at S&P Dow Jones Indices.

Simply put, we're on track for another record year of dividend payments.

Companies aren't just paying dividends, though. They're hiking the payments, too.

In the third quarter, 475 companies increased their dividend payments. Only 44 companies cut them.

To put it in dollar terms, net dividend enhancements (defined as dividend hikes + extra dividends + reinstated payouts, minus cuts and omissions) rose by 35% to $11.9 billion.

Like I said, we're in the midst of a payout party. And it's perfectly natural to think that such good times can't last. But the data suggests otherwise…

~ Bullish Dividend Factor No. 1: A Trillion-Dollar Stockpile

Unlike the U.S. government, corporations can't dole out money they don't have. But the good news is that companies aren't even close to overdrafting their accounts.

Instead, they're sitting on a near-record amount of cash - $1.1 trillion, according to the latest estimates from S&P Dow Jones Indices. So not only can they easily afford to keep paying dividends, but they can afford to increase those dividends, too.

~ Bullish Dividend Factor No. 2: Flush With Profits

Companies might be paying out a lot of money via dividends in dollar terms. As a percentage of profits, though? Not so much.

Or as Silverblatt says, "Companies are paying more than they ever paid, but compared to what they're making, they're not paying that much." The numbers clearly bear this out…

The current dividend payout ratio for the S&P 500 stands at 36%. Granted, that's up from 33% in the second quarter. However, it's still miles away from the long-term historical average of 52%.

That means companies don't even have to touch their cash stockpiles to increase their dividends. They can simply start sharing more of the profit pie with investors.

~ Bullish Dividend Factor No. 3: Show Me the Money… Or Else!

In a slow-growth world, CEOs of the largest companies understand the need to show investors the money. Otherwise, those investors will bail.

Companies have two choices here. They can either buy back shares in the open market, or pay dividends. Obviously, investors prefer the latter because we actually receive the money.

Don Thompson, CEO of McDonald's (NYSE:MCD), gets it: "Our philosophy on the use of capital remains unchanged, with our first priority being to reinvest in our business to drive sales and cash flow… After these investment opportunities, we expect to return all of our free cash flow to shareholders over the long-term through dividends and share repurchases."

By the way, he made those statements on the heels of announcing a 5% dividend hike.

And Steve Ballmer, outgoing CEO of Microsoft (NASDAQ:MSFT), gets it, too. Last month, he increased the company's dividend by 22%.

Prepare for Another Bout of Dividend Increases

Add it all up, and there's no way the dividend bubble is about to burst. On the contrary, in fact.

Given record cash balances, substantial profits and investors' hunger for yield, I fully expect companies to keep increasing their dividends at a record pace in the fourth quarter. And I'm not alone.

"At this point, we expect the fourth quarter to be a busy positive period," says Silverblatt.

On Thursday, I'll share a trio of companies that I expect to announce dividend increases before the end of the year, so we can grab a little more income.

So let the good (dividend) times roll. Just keep the fist pumps to yourself, please.

Safe investing,

Louis Basenese

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.