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Monday December 03, 2012
History, dividends & taxes
by Marvin Appel, editor Systems & Forecasts Conventional wisdom holds that any major increase in taxes on dividends will operate to the detriment of high-dividend stocks. But studies suggest that while they may be in store for several months of underperformance, their longer term attractiveness is likely to remain intact. A study by Morgan Stanley shows the relative performance of the top third of stocks by dividend yield compared to the entire market in the months surrounding increases in the spread between the tax rates on dividends and the rates on long-term capital gains (1975-2012). During the year before the dividend tax increases, high-dividend stocks performed close to the broad market. However, during the six months following the rise in dividend taxes, the high-yielders lagged the overall market by 3%. After the six months of lagging, however, dividend stocks actually outperformed in months 7-12 by a little over 1%. The study also shows that from 1970-2012, the top-third of stocks in terms of dividend yield outperformed the overall market, regardless of the relative tax rates on dividends and long-term capital gains. Paradoxically, the margin of outperformance for high-yielding stocks was greatest during those periods when dividends were most heavily taxed compared to capital gains. I would not conclude that high taxes are good for high-yielding stocks. Rather, I interpret these results to indicate that the investment climate, such as whether value stocks are favored, is a more important determinant of relative performance than is the relative tax rate on dividends. The decision to hold high-yielding stocks should not be made with taxes in mind as a primary consideration, because historically, their relative investment performance has not depended on the tax environment. Of course, this does not guarantee that high-dividend stocks will outperform in the future to the extent that they have in the past. Nonetheless, these historical observations are reassuring for investors who rely on dividend stocks to meet their objectives. Precedent suggests that the tax hikes are not a reason to abandon any dividend-oriented strategy you may be following. Learn more about this financial newsletter at Marvin Appel's Systems & Forecasts. 
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