Investors Turning to Dividend-Paying Stocks See Benefits of Buybacks, But Must Heed Caveats

NEW YORK (MainStreet) — It keeps going and going and going — life with low interest rates, that is. And that's been awfully tough for income-oriented investors such as retirees.

That's why many have turned to dividend-paying stocks, or funds that favor them. Today, the dividend yield on the Standard & Poor's 500 hovers around 2%, versus less than 1% in a money market account.

And some experts say dividends are even higher when the extra boost from stock buybacks is added in. That "buyback yield," as Morningstar terms it, is around 3% for the S&P 500, bringing "total yield" to 5%. Any income-oriented investor should be happy with that.

"To take full advantage of this phenomenon, investors should look beyond dividend-focused strategies to funds that invest in companies that have above-average total yield," writes Tim Strauts, senior markets research analyst at Morningstar, in an analysis of yield. Focusing on dividend yield alone, he says, is "shortsighted."

In a buyback, a company uses cash to purchase its own shares, effectively reducing the number in circulation. If corporate earnings remain the same, earnings per share rise after the buyback, pushing up the share price.

Over the years, many companies that once would have raised dividends to disburse extra cash have come to prefer buybacks, partly because a rising share price does not cause a tax bill until the shares are sold, while dividends are taxed in the year received. Also, many executive compensation plans emphasize rising share prices, and shareholders, who object strenuously to dividend cuts, don't fuss if buybacks aren't conducted every year.

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