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Are Dividends Important? By: Todd Bunton March 08, 2014 "Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies." - Benjamin Graham Investing in dividend stocks isn't just for retirees. If you're serious about generating strong long-term returns, then dividend stocks need to be a big part of your portfolio. Not only do dividend stocks have less volatility year-to-year, they outperform non-dividend paying stocks over time too. That's right - those "boring" dividend stocks offer lower risk and higher total returns over the long run than those glamorous non-payers. After last year's nearly +30% run up in the market, you might have forgotten that total return comes from two sources: price appreciation and dividends. And believe it or not, over the last 80+ years, dividends have accounted for more than 40% of the total return equation. Investors who focus solely on price appreciation are implicitly hoping that someone will come along one day and pay them more than they paid for a stock. But as history shows us, this can lead to disappointing results for investors over very long stretches. And considering that stock prices are back at all-time highs while the cyclically adjusted P/E ratio is near a lofty 26x, investors could very likely be disappointed with price returns over the next 10 years too. But those focused on income have enjoyed stronger - and steadier - returns. Dividend Stocks Outperform Just how important are dividends to your portfolio? A recent study by Ned Davis Research shows that dividend-paying stocks outperform their non-paying counterparts by a dramatic amount. From 1972 through 2013, non-dividend paying stocks earned a measly +2.3% return per year. But dividend-paying stocks crushed it with a +9.3% average annual return. And those that paid a dividend and raised it year after year did even better - generating a compound annual return of +10.1%! Look at the dramatic effect this had on the growth of a $100,000 portfolio over that time: A Bird in the Hand… With tens of billions of dollars trading hands every day within the stock market, it's easy to forget that stocks are not just pieces of paper. They represent ownership interests in businesses. Assume for a moment that you don't get a quote every day for your shares in that business and that you can't sell your ownership interest for several decades. Your focus would likely shift from price to value. And the value of that business, whether publicly traded or privately held, is the present value of all future cash flows. After all, what is the point in owning a business - or any investment - if you're never going to receive any cash from it? When a company generates positive free cash flow, it has several options. The company can let that money sit in the bank, fund organic growth, make acquisitions, pay down debt, or return it to shareholders through dividends or stock buybacks. Many growth investors might view dividend payments negatively. But why would anyone want management to plow back all of the company's cash regardless of the returns it will generate? Shareholders, just like any owner, should be concerned about maximizing long-term value, not short-term EPS. Dividends Making a Comeback? Historically, companies have paid out a little over half of their earnings in the form of dividends, while the stock market has averaged a dividend yield of 4.4%. But the roaring bull market of the 1980s and 90s shifted focus away from dividends. By the year 2000, the payout ratio was hovering around 30%, while the market was yielding just 1.2%. But after a decade of negative price returns, dividends appear to be making a bit of a comeback. The number of companies in the S&P 500 paying dividends (418) is at a 16-year high. And the current payout ratio of 32% is near a 10-year non-recessionary high as the dollar amount of dividends paid has more than doubled since 2004. Despite record high prices, the S&P currently yields 2.0%. Dividends are becoming more and more important to companies, as they should be to every investor. The Bottom Line Whether you're an income-hungry retiree or someone looking to maximize long term total returns, dividend stocks are critical to your success. They have not only been less volatile, but they have generated much stronger total returns too. And, of course, total returns are the name of the game. Today, you are invited to check out a portfolio I am managing that is designed to smooth your trajectory toward beating this year's more volatile market. It is called Zacks Income Plus. It starts with stocks paying high dividends (more than twice the average for S&P companies). The Plus is that we isolate the ones that also have potential for booming stock appreciation in the months and years ahead. Today, in fact, 9 of our stocks are gaining well into the double-digits and our indicators suggest that the end for them is not yet in sight. Would you like to find out more about this portfolio? Click below and you'll also see two new moves I am exploring right now. Even better, you can see all picks not only from Income Plus , but from all of the other Zacks services for a sum total cost of only $1. Good Investing, Todd Todd Bunton, CFA is Zacks Growth & Income Strategist. He manages our Income Plus Investor, which detects companies that not only pay high dividends but are also likely to see exceptional price appreciation. ................
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