Disappearing Dividends?

By Daniel Kadlec

Cash dividends to shareholders are disappearing quicker than Bill Clinton's credibility. Last year companies in the Standard & Poor's 500 paid out only 37% of their earnings as dividends, an all-time low. The average payout since 1945 is 52%. Corporate stinginess has helped drop the S&P 500 dividend yield (dividend divided by stock price) to 1.6%--so subterranean that merely calling it an all-time low doesn't do it justice. It is less than half the postwar average yield of 4.1% and way below the previous low-water mark of 2.6% in 1987.

The case of the disappearing dividend isn't hard to solve. As share prices have soared in recent years, dividends have come to be regarded as only slightly more relevant than the gushing palaver in an annual report. In this so-called new era for investing, perfectly healthy electric utility companies--the widows-and-orphans stocks long known for generous dividend policies--have been slashing their payout rates without a trace of remorse. "It's worked out splendidly," says John Hodowal, chairman of Ipalco Enterprises, based in Indianapolis, Ind., who last year short-circuited the dividend by 32% and immediately bought back 22% of outstanding shares. What's so splendid? Last year Ipalco shares, including dividends, returned 58%--double the Dow and triple the average utility. A Florida power company, FPL Group, was the first healthy utility to take the step, in 1994. Its stock too has dazzled.

Utilities are being deregulated, so they have an unusual reason to change policy and hoard cash. But the day is fast approaching when all kinds of thriving companies will ditch their dividends and use the savings to buy back stock to boost their share price. Specialty toolmaker SPX Corp., in Muskegon, Mich., made the move last April. Lo and behold, the stock has been rising twice as fast as the Dow.

Look for some blue-chip companies to step up next. Who might make the bold move? Among the giants, companies like Wal-Mart, Disney and Home Depot are good candidates. They are fast growing and pay woefully small dividends anyway. Disney, for example, has the lowest dividend yield of the 30 companies in the Dow, at 0.55%. You couldn't feed a mouse on that.

Certainly, some investors who live off dividends would cut and run. But there are powerful pro-investor arguments for dumping the dividend. One is that many investors reinvest dividends anyway and incur transaction costs to do so. But the main argument is that dividends are taxed as ordinary income, a marginal rate of up to 39.6%, while long-term stock gains are taxed as capital gains, a much lower rate of 20%. So it makes sense for companies to use their cash to buy back stock. Yes, a bear market could devour this strategy. But as long as the tax code clearly favors capital gains, dividends will dwindle--and nothing would make that plainer than a healthy blue chip wiping out its dividend altogether.

Daniel Kadlec is Time's Wall Street columnist. Reach him at [email protected]