The Dark Side of the Dividend Boom

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Dividends made a comeback in 2005. And it looks like the trend is here for the long term. After bottoming at 1.12% in March 2000, the yield on the stocks in the Standard & Poor's 500 has climbed to a recent 1.83%.

That's still far shy of the historical average yield of 3.92% for the period that began in 1925. But according to recent projections by Boston money manager Eaton Vance(EV Quote), the trend toward higher dividends will run at least through 2010. The payout ratio -- the percentage of earnings a company pays out in dividends -- will rise during that period to 50% from today's 32%. To put that in context, the dividend payout ratio since 1936 has averaged 54%.

This swing of the pendulum from historic lows to something like the long-term average will do more than just put more dollars into the quarterly dividend checks that companies mail out. It will change market volatility, shift the relative desirability of stock sectors and amend the growth rate in the economy as a whole.

Let's take a look at the difference this dividend comeback will make over the next five years.

Lower Volatility

It's not a coincidence that the bursting of the stock-market bubble and the low dividend yield for this market cycle both came in March 2000. Historically, dividends have acted to put a floor under stock prices and provide investors with a decent return, even when stock prices are headed south.

So, for example, in the 10 years from the beginning of 1966 to the end of 1975, a truly dismal period for stock investors, the S&P 500 averaged a total return of just 3.3% a year, according to Ibbotson Associates' long-term data on the stock and bond markets. (By the way, the total return in real dollars was even worse in that period, since inflation averaged 5.7% a year.)