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Dividends4Life (43.19)

Stocks Delivering The Dividend Dream

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September 26, 2012 – Comments (1) | RELATED TICKERS: ABT , KO , MMM

I have a dream that one day dividend stocks will rise up and decline under the threat of an Obama tax increase and live out the true meaning of their creed: “We hold these truths to be self-evident: that all stocks are not created equal.”

I have a dream that one day battered down dividend stocks in the sweltering heat of an unjust tax increase, will be transformed into an oasis of untapped value and significant yield. I have a dream that my investments will one day live in a market where they will not be judged by their underlying business fundamentals but by the media-driven fear of irrational traders. I have a dividend dream today.

Apologies to Martin Luther King for the puns, but a lot of the media fear-mongers are taking the possibility of higher taxes on dividends a little bit too seriously.

As a reminder, unless Congress acts before year-end, future dividends will be taxed as ordinary income. Currently they are taxed at maximum rate of 15% tax. In addition, ordinary-income tax rates will return to a maximum of 39.6%. Add to than a new 3.8% tax to help pay for Obama's Affordable Care Act, for a total of 43.4%. So dividend taxes would nearly triple for some taxpayers.

The September 5, 2012 Wall Street Journal article The Bullish Case for Dividend Stocks makes several points that we should not lose sight of:

- Dividend-paying stocks have outperformed non-dividend shares even when taxes were much higher.
- Dividend payouts were long taxed at ordinary-income rates—as much as 91% in the late 1950s and early 1960s, 70% in the 1970s and 50% by the early 1980s.
- If the era of low dividend taxes ends, dividend stocks should hold their appeal for several reasons.
- The 43.4% dividend tax may look onerous, but in reality it is the maximum rate for households earning more than $250,000.
- A large portion of investors stocks are in a tax-deferred retirement account, where dividend income and capital gains grow untaxed until withdrawn.
- Dividends are baby-boomer magnets. Expanding ranks of retirees will embrace companies that have given shareholders a dividend year after year and steadily increased them.
Bottom line: Quality blue-chip dividend stocks have done well for decades before they received favorable tax treatment and will continue to do so even if the the Bush Tax cuts are allowed to expire. Here are several dividend stocks that have paid dividends and thrived with and without favorable tax treatment over the last 40+ years:

PepsiCo, Inc. (PEP) is a major international producer of branded beverage and snack food products. The company has paid a cash dividend to shareholders every year since 1952 and has increased its dividend payments for 40 consecutive years.Yield: 3.1%

Abbott Laboratories (ABT) is a diversified life science company that is planning to split into two publicly traded companies, one in diversified medical products and the other in research-based pharmaceuticals. The company has paid a cash dividend to shareholders every year since 1926 and has increased its dividend payments for 40 consecutive years. Yield: 3.0%

Illinois Tool Works Inc. (ITW) is a diversified manufacturer operates a portfolio of 60 business units that serve industrial and consumer markets globally. The company has paid a cash dividend to shareholders every year since 1933 and has increased its dividend payments for 49 consecutive years. Yield: 2.5%

Colgate-Palmolive Company (CL) is a major consumer products company that markets oral, personal and household care and pet nutrition products in more than 200 countries and territories. The company has paid a cash dividend to shareholders every year since 1895 and has increased its dividend payments for 49 consecutive years. Yield: 2.4%

Johnson & Johnson (JNJ) is a leader in the pharmaceutical, medical device and consumer products industries. The company has paid a cash dividend to shareholders every year since 1944 and has increased its dividend payments for 50 consecutive years. Yield:

The Coca-Cola Company (KO) is the world's largest soft drink company and also has a sizable fruit juice business. The company has paid a cash dividend to shareholders every year since 1893 and has increased its dividend payments for 50 consecutive years. Yield: 2.7%

3M Co. (MMM) is a diversified global company that provides enhanced product functionality in electronics, health care, industrial, consumer, office, telecommunications, safety & security and other markets via coatings, sealants, adhesives, and other chemical additives. Yield: 2.5%

The Procter & Gamble Company (PG) is a leading consumer products company that markets household and personal care products in more than 180 countries. The company has paid a cash dividend to shareholders every year since 1891 and has increased its dividend payments for 55 consecutive years. Yield: 3.3%

Emerson Electric Co. (EMR) designs and supplies product technology, and delivers engineering services and solutions to a wide range of industrial, commercial, and consumer markets around the world. The company has paid a cash dividend to shareholders every year since 1947 and has increased its dividend payments for 56 consecutive years. Yield: 3.2%

My dream scenario would be the financial talking heads convince dividend investors that the sky was falling and they need to sell everything. Price plummets on fear (fundamentals remain unchanged). A window of opportunity opens for those of us looking for value and willing to buy in a "scary" market. After I am fully invested, a congress reacts to a backlash from those living on dividend income and the Bush tax cuts are reinstated. Yes Dr. King, I can dream too...

Full Disclosure: Long PEP, ABT, ITW, JNJ, KO, MMM, PG, EMR. See a list of all my dividend growth holdings here.

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1 Comments – Post Your Own

#1) On September 26, 2012 at 9:57 AM, edwjm (99.87) wrote:

"As a reminder, unless Congress acts before year-end, future dividends will be taxed as ordinary income."

This is not true, no matter how many times this gets said (mostly by Republicans).  Without getting into the idiological disputes surrounding this issue, let me say that year end is not some kind of irrevocable deadline for changing this.  In fact, for political reasons, Democrats intend to delay making any changes to the tax code until after year end. 

I don't know whether or not they will be sucessful with this delaying tactic and I don't know whether the rate on dividends will be allowed to return to former rates or not.  But this I do know:  The end of the year is not some kind of irrevocable deadline!  Changes could be passed after New Years', and made retrocating to the first of the year.  In fact, I see this as the most likely scenario, although I have no idea what will happen to the tax on dividends.

I see that dividends are effectively double taxed, but the whole point of investing is to get a return on money invested, not tax avoidance.  As long as the taxes on dividends amount to less than 100% (and they certainly do), dividends will be an important consideration in investing.

As for the double taxation of dividends, there are at least three possible cures:

(1) reduce or eliminate the tax on dividends

(2) reduce or eliminate corporate taxes

(3) Allow corporations to deduct dividends paid as an expense, just like they deduct interest.

I personally favor (3). 

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