Good News for Dividend Lovers: 2012’s Lusty Stock Market Start Has Left Dividend-Paying Stocks Behind

Well, that was quick. In 2011, dividend-paying all-stars of the S&P 500 index decisively beat the overall index. It was a man-bites-dog story that dominated much of year-end market reviews and outlooks for 2012. But a spurt of New Year enthusiasm for the U.S. economy and U.S. stocks has put veteran dividend payers back into in second-class status, where they’ve been for most of the last 20 years.

Exchange-traded funds that track the S&P 500 (SPY) and the major S&P 500 dividend stocks (SDY) tell the story:

SPY vs. SDY, 5-year % change:

SPDR S&P DIVIDEND IDX FD Stock Chart by YCharts

SPY vs. SDY, 2011 % change:

SPDR S&P 500 Stock Chart by YCharts

SPY vs. SDY, 2012-to-date % change:

SPDR S&P 500 Stock Chart by YCharts

Despite the cash hordes held by corporate America and an aging population demanding income from their investments, dividend-payers have been out of favor since the mid-1990s, when the rise of executive stock options ruined incentives in corporate suites. Option-holding CEOs came to be motivated by stock prices gains instead of profits. They, transformed business management from the task of producing cash for investors into producing artifices, such as PR and share repurchases, that boosted stock prices.

As veteran stock picker Ralph Wanger, who used to run Columbia Acorn Funds, noted several years ago, “the CEO with a big stock option grant in his pocket cares only about stock price, because dividends are not in his payment formula… The CEO has an incentive to eliminate dividends and use the cash to buy back stock” thereby reducing the earnings per share drain caused when the company grants him executive stock options.

Wanger’s call for giant institutional shareholders to demand that more companies pay steady dividends hasn’t transpired, despite evidence that dividend payers generate long-term capital gains more consistently than dividend laggards.

This year’s new members of the Standard & Poor’s list of dividend “aristocrats,” companies that have increased dividends annually for at least 25 straight years, illustrates the point. Steel maker Nucor (NUE) joined the list at the end of last year. Its return on invested dollars consistently outshines U.S. Steel (X).

Among competing dividend “aristocrats,” the dividend payout ratio, the amount of profits paid to investors as dividends, is a useful metric for comparison. Here, you’re looking for a Goldilocks result—not too much, not too little but steady.

A newly crowned dividend “aristocrat” this year, Genuine Parts (GPC), with a current payout ratio of nearly 50%, looks far more reliable for income-seeking investors than competitor “aristocrat” Leggett & Platt (LEG), which is paying out almost 90% of profits to support its dividend track record.

Leggett & Platt Payout Ratio TTM Chart by YCharts

Genuine Parts Company Return on Invested Capital Chart by YCharts

Despite a 2011 in the lime light, high-quality dividend-paying stocks still are not in vogue on Wall Street. But steady payers deserve a second look, even if we get an election-year rally in stock prices.

Bill Barnhart is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.