In the changeable game of investing, the recent revival of dividends may look like just another passing fancy.
Cash payouts by corporations fell utterly out of fashion in the soaring stock market of the 1990s. When the great price-appreciation machine broke down in 2000-02, dividends came back into vogue, with an assist from a change in U.S. tax laws.
The cycle always turns. So come the next sustained bull market, it might be natural to assume that dividends will be shunted aside again.
Natural, but not necessarily correct, suggests Ralph Wanger, a 45-year star of the mutual fund firmament who retired in 2003 as manager of a mutual fund group that includes the $14 billion Columbia Acorn Fund.
"Dividends matter," declares a commentary by Wanger, who at age 71 remains an adviser and trustee, in the funds' latest quarterly report. "An investor, given a choice between capital gain potential (uncertain because the stock market does odd things sometimes) and dividends (much more stable), should prefer the dividends because they are a lot less risky."
Wanger's views carry some extra force when you consider that he has always specialized in stocks of smaller, up-and-coming companies. In this realm, managements are supposed to be using all the capital at their disposal to maximize growth opportunities, aren't they?
"In the Columbia Acorn Fund portfolio, 53 percent of the fund's stocks don't pay dividends," Wanger writes. "We wish more did."
He cites 2003 research by analysts Robert D. Arnott and Clifford S. Asness that found higher earnings growth equated with higher dividends -- just the opposite of the standard assumption.
"Dividends went away because corporate management and shareholders had different payouts," Wanger says. "Dividends are a very fine thing for shareholders. However, the CEO with a big stock option grant in his pocket cares only about stock price, because dividends are not in his payment formula. In general, the CEO has an incentive to eliminate dividends and use the cash to buy back stock to support the price."
Investors have some ready means of dealing with this divergence of interests. Analysts on conference calls with management can harp on dividends. Even lowly individual investors can cast a ballot for their preference by buying stocks and stock funds that give dividends their due.
Evidence is mounting that this message is already getting through. According to data compiled by Standard & Poor's Corp., companies voted 935 dividend increases in the first five months of this year, up from 791 in the comparable period of 2004 and 692 in January to May 2003. Extra dividends are up as well, while decreases and omissions are on the decline.
In these fast times, dividends still suffer from a plodding image. The aggregate yield of the Standard & Poor's 500-stock index, at a skimpy 2 percent, represents only a sliver of the kind of return people want to envision if they are going to brave the stock market. For any kind of instant gratification, dividends simply will not serve.
What this overlooks is that dividends can grow and compound. In the 12-month period through May, according to Bloomberg, price appreciation accounted for more than three-fourths of the S&P 500's gain. In the past 25 years, by contrast, price appreciation accounted for only about 45 percent of the index's 2,138.4 percent advance.
The figures for the past 25 years look all the more remarkable when you stop to consider what that period was like. It was dominated by the very sort of bull-market conditions that make people forget about dividends altogether.
In the struggling 1970s, stock price appreciation produced a measly 22 percent of the S&P 500's return. If investors face another extended spell of lower returns now, as many sages maintain, similar proportions may be in store.
Whatever comes next, lean years or fat, dividends will continue to exert a potent claim on investors' attention. "There are many companies that could pay a dividend, but management chooses not to do so," Wanger says. "Has modern financial theory made dividends obsolete? No."