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POINT

Taxes, Growth Opportunities Make Dividends Less Relevant
Dividends- regular cash payments to owners of common stocks- have been relegated to a "bit player" role in stock market returns in recent years. The dividend yield of the Standard & Poor's 600 Index is at a record low of 1.2%. One-fifth of the stocks in the blue chip index, representing nearly one-quarter of its market value, pay no dividends at all. Here are three reasons for the declining relevance of dividends.

1. Dividends are taxed twice.
Dividends are paid out of profits after companies have paid income tax on their earnings. Then, after stockholders receive their dividends, the payments are taxed again-as ordinary income subject to rates as high as 39.6%.This double-taxation problem is one reason that many I companies use excess cash generated by their operations to repurchase shares of stock on the open market. If share repurchases succeed in raising a stock's price, an investor can reap that gain by selling shares. Capital gains from shares held for more than one year are taxed at lower rates than ordinary income-the maximum capital gains rate is 20%. The tax system makes paying dividends relatively unattractive for companies and their shareholders.

2. Firms can use the cash elsewhere.
Companies can use earnings and cash flow to pay dividends to their shareholders or to reinvest in the business to boost future profits. Investment opportunities abound these days because of technological innovations, the opening up of global markets, and the reduction of government regulation. Therefore, many companies believe that they can serve shareholders better by retaining earnings for expansion instead of paying them out in dividends.

3. Some pay off debt instead of paying dividends.
Some companies would rather use cash to pay off existing debt or to avoid new borrowing than to pay dividends on their stock. Such a decision reduces the interest a company would otherwise have to pay and provides a greater financial safety cushion for a company in the event of a downturn in business. Keeping dividend payouts low can be a prudent move for a company.

COUNTERPOINT

Stock Dividends Still Matter; Low Payouts Are A Danger Sign
Are remarkably long, strong bull market has led stock investors to underrate dividends. The Wilshire 5000 Total Market Index has recorded average annual returns of about 17% over the past 20 years, so many investors are focused only on capital gains, not on dividend income. Here are three reasons investors should care about dividend yields.

1. Dividends are a bird in the hand.
A stock investor can make money in only two ways receiving dividends or selling shares at a profit. Dividend payments are pretty reliable and they're real- you can spend them or reinvest them. In contrast, price appreciation is far from certain. With stock prices very high by historical norms in relation to such fundamentals as earnings and net worth, further gains may be hard to come by. The great bull market of the 1980s and '90s and the economic expansion that began way back in 1991 won't continue forever. In a downturn, the joy of dividends will be rediscovered,- they can help investors , "stay the course" while waiting for prices to rebound. And for investors who hold stocks in tax-deferred accounts, such as IRAs or 401 (k)s, dividends and capital gains are ultimately taxed at the same rate.

2. Dividends are a signal.
Economic studies generally have found that dividends are a signal from corporate managers that they have confidence in their company's future. Because dividend reductions are typically very damaging to a company's stock price, companies usually don't institute or increase a dividend unless they feel sure the company's earnings will support the payments.

3. Dividends are key in total returns.
Vanguard calculates that from 1925 through 1999, dividends were responsible for two-fifths of the 11.2% annual average total return on the S&P 500 Index (4.7% of the 11.2% return). Even in the roaring '90s, dividends contributed significantly to returns. Dividends, together with the compounding effect of reinvesting them, accounted for 3.1 percentage points of the 16.9% annual average return of the Wilshire 5000 Total Market Index during the 1990s. And for millions of retired investors who count on them to help pay their living expenses, the importance of dividends is obvious.

Source: "IN THE VANGUARD" , Winter 2000

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