Dividend Paying Stocks

With today's relatively low interest rates many retirees and other investors are turning to dividend paying stocks to provide them with a reliable stream of income.  In fact, investing in companies paying high dividend yields is often viewed as the "sensible" or "rainy day" approach to creating an investment portfolio.

Companies Paying High Dividends

Industries traditionally paying high dividends included utilities and financial institutions.  This occurred for many different reasons, but if we use electric utilities as an example we can conclude that high dividends were often the result of limited investment opportunities.  Let's take a closer look at this example because it helps us understand why companies offer dividends to their stockholders in the first place.

If you were the Chief Financial Officer of an electric utility you have a choice to make at the end of each earnings period.  You can use earnings to pay down debt, or to repurchase shares of common stock thereby adjusting the financial leverage of the company.  You can also use earnings to reinvest in the company itself - a strategy that might be used by a company with a lot of growth potential.  Finally, you can return earnings to your shareholders in the form of dividends.

In reality the CFO is always evaluating opportunities to use earnings in a way that provides the greatest benefits the shareholders.  But often the alternatives are limited - especially for some companies.

For example, most electric utilities have a fixed franchise territory.  Those electric utilities that are in well-developed states may not have a lot of opportunity to grow their business - they are limited by the geographic size of their franchise territory.  So the CFO makes a decision to return a larger proportion of earnings to shareholders in the form of dividends.

Dividend Paying Stocks of the Dow

Now that you have an understanding of why a company might offer shareholders a high dividend yield, you might be wondering what kind of yields are we talking about?  We used a stock screener pull a list of stocks that are members of the Dow Jones Industrials and also paying dividends in excess of 3.25% as of November 2007.

If we look at the smaller set of the Dow Jones Utilities, those stocks paying dividends in excess of 3.25% include:

If we step back and analyze this information we can see that six of the thirty stocks (20%) in the Dow Jones industrials were paying dividends of 3.25% of higher.  Of the 15 stocks in the utility index, seven of these (47%) were paying high dividends.  So it seems that our theory of utilities paying high dividends does hold true.

Dividends and Taxes

Recent changes to tax code make the payment of dividends to investors even more attractive.  That's because qualified dividends are now taxed at a lower rate than ordinary dividends as explained below.  This has resulted in even higher dividend payout from stocks of those companies already providing investors with good yields.

Ordinary Stock Dividends

Ordinary dividends are paid out of the earnings and profits of a company.   They are federally taxable as ordinary income unless they meet the standard test for qualified dividends.  Said quite simply, ordinary dividends are those that do not meet the standards or requirements to be considered qualified dividends.

Qualified Dividends

Qualified stock dividends are ordinary dividends received in tax years after 2002 that are subject to the same federal income tax rate as net capital gains (5% or 15% maximum tax rate).  If your applicable "regular" tax rate is 25% or higher, then the qualified dividends are taxed at the new 15% capital gains maximum.  If your "regular tax" rate is less than 25%, then qualified dividends are taxed at the new 5% capital gains rate.

Capital Gains Eligibility Rules

For stock dividends to be eligible for the new capital gains rates, those dividends must meet all of the following requirements:

• Dividends must be paid by a US corporation or a qualified foreign corporation.
• Dividends cannot be those that are specifically excluded from qualified dividends (included capital gains, dividends from savings bank accounts, dividends on ESOPs).
• Stock holding periods must be met.  For common stock, the holding period is more than 60 days of a 121-day timeline (60 days before the stock goes ex-dividend and 60 days after the ex-dividend date).  Preferred stock must be held for more than 90 days of a 181-day timeline (90 days before the stock goes ex-dividend and 90 days after the stock goes ex-divided).

About the Author - Dividend Paying Stocks

Copyright © 2005 - 2007 Money-Zine.com

Stock Market Resources on the Web