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Investors Increasingly Seek Dividend-Bearing Funds

NEW YORK - A decade ago, investors snubbed dividends as a sign of companies incapable of growth, but since 2003, dividends have become a symbol of security and strength. And they're back in demand.

How long that will last, though, may depend on whether the 2003 tax laws that reduced the rate investors pay on these payouts are extended past 2008, when they are set to expire. If they are extended, the next question is whether Congress goes for a quick-short-term fix, as expected, or a long-term overhaul, according to experts.

"We've turned a corner," said Howard Silverblatt, a senior index strategist with Standard & Poor's of New York. Silverblatt was among four panelists to participate in a discussion on the resurgence of dividends and related public policy impact here last week, at a seminar organized and hosted by Boston-based Eaton Vance. "Investors are looking for total return," Silverblatt said.

Dividend-bearing shares offer just that. Although their value typically doesn't swell as quickly as their non-paying counterparts, when dividend-bearing shares drop, the decrease is not usually as steep, either. And then there is the guarantee of quarterly cash, which can be reinvested, used to buy other stocks or spent.

Companies like issuing dividends, because in an era of low interest rates and slow growth, it provides a tax-efficient way to clear excess cash from their ledgers, and acts as an added incentive to attract investors.

Dividends also owe much of their renaissance to the 2003 reforms to the tax code. Those changes dropped the dividend tax rate investors pay from 35% to 15%. Since then, the number of dividend-paying stocks and mutual fund offerings has increased. Last year, for example, 387 of the S&P 500 stocks paid dividends, compared to 351 in 2002, the year before the new law took effect.

Investors seek dividends for other reasons, too.

Those who can still hear the echoes from the burst technology bubble reverberating throughout Wall Street's concrete canyons learned that they can't always count on charge-ahead, bull market capital gains. Rather than go back down that road, they choose the less bumpy, albeit typically slower, path of dividend-bearing investments.

"Capital gains are hope at the end of the journey," Silverblatt said.

On the other hand, "dividends are a pay me now' mentality. Investors can take the dividend and reinvest it any way they like, or use it for current income," said Tom Roseen, a senior analyst with Lipper of New York.

That may be especially attractive to Baby Boomers facing fixed-income retirement and looking for cash, he said.

"We see a change in the way people think about the stock market, the way people think about taxes and the way people think about dividends," said Duncan W. Richardson, executive vice president and chief equity investment officer at Eaton Vance, and moderator of the panel discussion.

In the mid 1990s, close to 90% of companies in the S&P 500 index issued dividends. But then, investors began to favor technology start-ups with frenetic capital gains growth, but no dividends, instead. By 2000, fewer than 75% of the S&P 500 stocks paid investors dividends. Likewise, in 2000, open-ended equity mutual funds delivered investors $244.7 billion in long-term capital gains, but only about $32.5 billion in dividends.

That trend is shifting. In an Eaton Vance survey of more than 400 American investors that it released in January, 57% said they prefer regular, quarterly dividends to stock buybacks, a common practice of the 1990s, or one-time or irregular special dividends. Seventy-eight percent of those polled said that they consider dividends a sign of a company's financial health. "Compared to the findings of earlier surveys, these results show a significant shift in investor preference from an emphasis on growth investing toward a more value-oriented, conservative investment style," Richardson said.

Companies and mutual fund complexes alike have responded. In 2005, 78% of the companies in the S&P 500 Index and 32% of all U.S. publicly held companies paid dividends, according to Silverblatt. In 2000, less than 33% of technology companies paid dividends. Now the technology sector is issuing dividends faster than any other, he said.

Likewise, in 2005, mutual fund investors saw $66.5 billion in dividend payouts, compared to $124.8 billion in long-term capital gains, according to Lipper data.

Another Eaton Vance survey released in January showed that of 217 finance executives at publicly held companies, 47% believed dividend growth would continue to outpace earnings in 2006, compared to 24% who disagreed and 29% who were unsure.

In other cases, non-index fund companies are paying "extra cash issues."

"It's the forerunner to the dividend," Silverblatt said. These companies may be considering announcing regular dividends, or simply trying to keep investors from selling in favor of buying into dividend-paying competitors.