Tax cuts, turbulent market make dividend funds popular

Tax cuts, turbulent market make dividend funds popular

Some investors are turning to dividend funds to wait out recent stock market turbulence after a one-year run-up. The popularity of the funds has also been aided by 2003 tax cuts, which had the effect of raising dividend payouts.


Dividend funds offer comfort in turbulent time
Associated PressPublished June 29, 2007
NEW YORK --

With the stock market having jitters after a strong run-up in the past year, some investors might want something more low-key.

Dividend funds, though still subject to the vagaries of the stock market, can give comfort to investors looking for more defensive arenas.

While dividend payouts have increased in recent years, thanks in part to federal tax cuts enacted in 2003, many of the large, established companies that are traditional dividend payers are sitting on record levels of cash. That makes it easier for them to pay dividends and repurchase shares.

The large-capitalization stocks that are typical dividend providers, such as those that populate the Standard & Poor's 500 index, operate differently from start-up companies that might be forced to reinvest most of their cash flow to support a nascent business.

Donald Taylor, a portfolio manager for the Franklin Rising Dividends Fund, looks not only for companies that make steady payouts but, as the name implies, also for those operations that are likely to boost their payments.

"We want companies that have a long record of consistent and substantial dividend increases," he said.

The fund screens for companies whose dividend has at least doubled over the past 10 years, though he notes that the approximately 45 stocks that make up the fund have done better than that.

On average the dividends in the portfolio have increased 22 years in a row.
Not surprisingly, many of the types of stocks that meet the fund's requirements are industrial, financial and consumer companies -- traditional dividend payers.

In recent years, Taylor noted, corporate earnings and cash flow have remained robust, giving many companies ample room to pay a dividend.

"Operating margins have been very strong and companies have been relatively cautious in reinvesting, so that leaves free cash flow strong," he said. "That leads to more and larger dividend increases and share repurchases."

Taylor cautioned that he avoids companies that boost their dividend payments at the expense of growth.

"What I'm not looking for is the dividend growing because of a big change in the payout ratio," he said. "Although there are certainly times when it's appropriate, it still has to be in the context of seeing the business grow in the longer term."

Jeff Tjornehoj, an analyst at fund-tracker Lipper Inc., offered a similar assessment.
"I would be cautious about pursuing yield without an eye for risk," he said. He noted that while there are companies with dividend yields above 10 percent, some might be in trouble.

"They got into that position because their stock prices are beaten down so badly," he said. "Just because a company's dividend yield is rising doesn't necessarily indicate bigger dividends. It can be the case that their prices are falling precipitously."

Tjornehoj said investors should consider the amount of turnover in a portfolio because some short-term gains can trigger higher taxes.

In general, Tjornehoj said, dividend funds aren't for people looking for the greatest returns but for a limited measure of dependability.

"They're not going to have returns that put everybody else to shame," he said. "If that's what you're looking for, then this may not be the type of fund that suits your needs. Take a broad view. Not only are you in it for the dividend but for the performance of the stock itself."

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