NEW YORK (CNN/Money) -
Now that President Bush has passed the $350 billion tax cut, which includes a big break on dividend taxes, there's a lot of chatter about high-yielding stocks.
To be sure, dividends have become much more valuable. But there are a lot of other factors to consider before buying a stock.
Start with price.
* as of 5/22/03 | Source: Thomson/Baseline |
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Stocks that pay dividends enjoyed a substantial run-up at the end of last year on anticipation of some sort of dividend tax relief.
The 50 highest-yielding stocks in the S&P 500 surged 27 percent from the market's Oct. 9 low point to Jan. 7, the day Bush formally proposed a tax cut. The S&P 500 gained 18.8 percent during that time frame.
But since Jan. 7, the top yielders have fallen 5 percent while the S&P 500 has inched up a percent.
"A short-term pop in dividend stocks is not likely," said James Denney, manager of the Electric City Dividend Growth fund. "The market has re-priced these stocks over the past five months."
Denney said that what's more likely to happen as a result of the tax changes is that companies that don't issue dividends may start doing so and that companies with small yields could increase their payouts.
Another issue that concerns some investors is the so-called sunset provision, which makes long-term planning difficult. Dividend taxes are slated to revert to current levels in 2009.
"I'm not looking to add a lot of income [dividend stocks] to my portfolio because of this," said Ted Parrish, co-manager of the Henssler Equity fund. "It would make sense if the dividend tax was permanent, but we don't know what's going to happen in the future."
Fundamentals matter more than yield
In addition, it's overly simplistic to lump high-yielding stocks in one camp and companies with low or no dividends in another. While stocks with a high yield are down, on average, over the past few months, there have been many standouts.
Energy, electric utilities and financial services companies in particular have been strong performers because of improving earnings.
Utilities Xcel Energy (XEL: Research, Estimates) and Public Service Enterprise (PEG: Research, Estimates) are up more than 25 percent this year while money center banks J.P. Morgan Chase (JPM: Research, Estimates) and FleetBoston Financial (FBF: Research, Estimates) have each gained more than 20 percent.
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But the telecom sector continues to be one of the worst performing sectors of the market. Baby Bells Verizon (VZ: Research, Estimates) and SBC Communications (SBC: Research, Estimates) and long-distance giant AT&T (T: Research, Estimates) all have dividend yields of at least 4 percent, but their stocks have suffered since revenue growth remains sluggish at best.
AT&T, despite a 4 percent yield, has plunged 29 percent this year.
"The performance of dividend-paying stocks has more to do with the fundamentals in their industries," said Linda Duessel, co-manager of the Federated Equity Income fund, which focuses on dividend stocks.
Duessel said she is underweighting telecom in her funds and has a heavier focus on energy companies like BP (BP: Research, Estimates) and ChevronTexaco (CVX: Research, Estimates).
Parrish also likes the energy sector. He owns ExxonMobil (XOM: Research, Estimates) and Royal Dutch Petroleum (RD: Research, Estimates). But he added that he is not looking exclusively for stocks with a high dividend yield.
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He seeks companies that can generate about a 12 percent total return and that most of this return comes from capital appreciation, not dividends.
And Denney said that he's favoring some financial stocks that have bounced back lately along with the broader market. Some that he owns include savings and loan Washington Mutual (WM: Research, Estimates), mutual fund company T. Rowe Price (TROW: Research, Estimates) and regional bank Keycorp (KEY: Research, Estimates).
So look at more than just the dividend. A stock that pays a dividend may be worth considering given the lower tax rates. But a company with strong earnings momentum is probably a better bet than a struggling firm that has little more to offer than a high yield.
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