Have We Gone Overboard on Equity Income?

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LONDON -- When everybody agrees exactly where you should put your money, this is usually a good signal to put it somewhere else altogether.

That was certainly the case at the start of 2011, when every investment advisor was busily tipping emerging markets, which subsequently fell 20%.

It was also the case at the start of this year, when everybody agreed stock markets were best avoided, just before they set off on a snorting bull run.


So where does everybody agree you should put your money now? Into dividend-paying stocks. Investment analysts and fund managers are all talking up the power of the dividend. So is almost every single Motley Fool contributor, above and below the line. Frankly, so am I.

Surely we can't all be right?

The case for dividends
In these days of low stock market growth, rock-bottom interest rates, and continuing economic uncertainty, who wouldn't want to buy solid global blue chip stocks paying handsome dividends?

Global blue chips are sitting on a mountain of cash, yet recent stock market falls have left many trading at lowly prices. U.K. dividends soared 25% in the first quarter to hit a record high.

Investors can choose from plenty of juicy yields, starting with these five shares with rapidly rising dividends, while this dividend is up 198% in four years.

Better still, you can enjoy delightful dividends for a decade. No wonder David Kuo is looking so cheerful these days. He is collecting blue chip dividends every month.

So am I, for that matter.

The bond across the pond
As you can see, there are plenty of great dividend opportunities out there. They look even more attractive when you consider the alternatives.

You could lend your money to the U.S. government and be grateful to get a yield of 2% (and lose sleep worrying about the government bond bubble). Or buy a corporate bond and pat yourself on the back for getting 3% or 4%.

Or you can simply leave it in the bank and be grateful with 1%.

The real yield
Alternatively, you can buy a defensive blue chip such as GlaxoSmithKline (NYS: GSK) on a forecast yield of 5.1% and undemanding P/E ratio of 11.9 times for 2012. You might also get capital growth on top.

Or you could buy oil giant Royal Dutch Shell (NYS: RDS.B) on a 5% yield and 7.6 P/E, and Vodafone (NAS: VOD) on a forecast yield of 7.4 and P/E of 10.9.

If you can stand the share price volatility, you can buy insurer Aviva (NYS: AV) on a forecast yield of 8.9 and P/E of 5.2.

Individual company shares are risky, of course, and look set for a difficult summer, but that shouldn't bother you too much if you are holding for five, 10, or 20 years, as I would recommend.

I own shares in all these companies and the dividends really cheer me up. I could also tell you how I own units in equity income fund Invesco Perpetual Income (current yield 3.8%), but I think you get the point.

Like everybody else, I dig dividends. And I haven't even mentioned that you might get capital growth on top as well.

So that's the case for. What about the case against?

Everybody's doing it
Before we get onto that, I want to share a piece of research from Capita that has just hit my inbox. It noted that recent sharp growth in U.K. dividends is "remarkable" given the collapse of the banking sector and BP's dividend suspension following the Gulf oil spill.

This only demonstrates just how healthy the remaining large U.K. corporations are.

The research also highlights the long-term glory of dividends. Somebody who invested 100,000 pounds in a balanced portfolio of investments March 1993 and reinvested all the dividends would have 379,606 pounds at the end of this March. That's an increase of 279%. During that time, inflation rose just 73%.

If that investor had spent his or her entire income, the capital would still be worth 196,615 pounds, while his or her annual income would have risen from 4,100 pounds to 7,400 pounds.

Capital growth and rising income. What's not to like? And that's at the end of a period when global equity markets faced their most challenging times since the 1930s.

If you're investing for the long term, as you should be, the dividend is a very faithful friend.

The case against
You can see why everybody is so hot on dividends these days. There must be something bad to say about them. So here goes.

Well, your capital could take a knock, if the eurozone crisis continues to savage markets. Mind you, as a long-term investor, I would see that as a buying opportunity. For solid, high-yielding, blue chip stocks.

I'm sorry. I couldn't help myself.

Sometimes the received wisdom just looks too damned, well, wise. If you're immune to the dividend story, tell me why below.

To learn more about dividend-paying shares, take a free 30-day trial to Motley Fool Share Advisor, where we recommend our top dividend share each month.

More from Harvey Jones:

At the time this article was published Harvey Jones owns shares in Aviva, GlaxoSmithKline, Royal Dutch Shell, and Vodafone.Motley Fool newsletter serviceshave recommended buying shares of GlaxoSmithKline and Vodafone Group. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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