During the 1990s, dividend-payingstocks were frequentlyoverlooked. Instead, investorsflocked to stocks with higher short-termgrowth potential. Recent marketvolatility, however, has spurred investorsto once again consider dividend-payingstocks as a means of insulatingtheir portfolios from downturns.
A dividend is simply a portion of acompany's net profit that can be distributedto shareholders. Typically, acompany's board of directors decideswhether dividends will be paid and, ifso, how much they will be worth.
Dividends can help increase astock's total return, which is definedas the sum of the dividend plus theprice movement in the stock. Totalreturn is often considered a bettermeasure of a stock's performancethan dividend yield or price movementalone, because it shows thetotal amount that a shareholder hasreceived by holding the stock over aperiod of time.
How does a dividend increase astock's total return? Let's say you purchaseda $40 stock that paid a $2 dividend.The stock's price increasedfrom $40 to $50 throughout the year.Your total return would then be 30%($10 stock increase plus $2 dividendprice divided by the purchase price of$40 equals a 30% total return).
On the other hand, if you hadpurchased a nondividend-payingstock for $40 and that stockincreased in value to $50 over thesame time period, your total returnwould be 25% instead of 30% ($10stock increase divided by the purchaseprice of $40 equals a 25% totalreturn). As you can see, dividendscan impact a stock's total return.
Besides increasing a portfolio'stotal return when stocks increase invalue, dividends can sometimes cushiona portfolio's loss when stocks declinein value. Say you purchased anondividend-paying stock for $50and the stock's price declined 20% to$40 by the end of the year. If the samestock paid a $2 dividend, you wouldhave lost only 16% instead of 20%.
If you are interested in incorporatingdividend-paying stocks into yourportfolio, there are 3 things you needto remember. Look at a company'sfundamentals first. A company shouldhave a good business outlook for thefuture, strong cash flow, and a proventrack record of building its businessover an extended period of time.
Joseph F. Lagowskiis VP investments
and a financial consultant
with A. G. Edwards in
Hillsborough, NJ. He welcomes
questions or comments
at 800-288-0901 or www.ag
edwards.com/fc/joseph.lagowski. This article
was provided by A. G. Edwards & Sons,
Inc, member SIPC.
Second, remember to diversifyyour holdings among a variety of sectors.Diversification prevents any 1sector from having too big of animpact on your portfolio's overallperformance. Third, once your portfoliois assembled, you and yourfinancial advisor should review it ona regular basis. Companies can electto reduce or eliminate their dividendat any time, and your financial advisorcan help keep you up-to-date onother investment opportunities thatcontinue to pay a dividend.