Generally speaking, dividends are a good thing. However, the double taxation that dividends are exposed to does not sit well with many. Dividends are taxed at the corporate level, and then again on the personal level when they are paid out to investors. So yes, in this regard, dividends may not be the optimal capital allocation decision. Yet, the majority of the time, dividends are indeed a valuable use of corporate capital.

IN PICTURES: 20 Tools For Building Up Your Portfolio

Capital Allocation
The truth of the matter is that a substantial portion of long-term capital gains comes from dividend payouts. And using company profits to pay dividends to stockholders creates discipline among the companies that issue them. Dividends are cash payments, and cash can not be manipulated. The payment of a quarterly dividend suggests that the company is generating the cash necessary to pay it. Also, managers are aware that many investors will dump shares if the dividend is eliminated. This knowledge reduces the likelihood that management squanders the cash on poor acquisitions.

On the flip side, should a dividend-paying company eliminate or suspend the dividend, that serves as a warning to investors that operations might be. So in weighing the pros and cons, it appears that the advantages of dividends outweigh the disadvantages. (For more, see The Power Of Dividend Growth.)

Three Huge Yields
Linn Energy (Nasdaq:LINE) is an oil and gas master limited partnership with an amazing 10% dividend yield. MLP's are in the business of owing stable oil and gas properties that produce stable cash flows. To maintain their tax efficient status, MLPs pay out most of their cash flows out to unit holders. Linn's yield is only half the story. The company also has one the best hedge books in the business. Over the next three years, nearly 100% of Linn's production is hedged at oil and gas prices at about current prices. This hedge book, along with the yield, makes Linn one of the most attractive MLPs in the business. Kinder Morgan Energy Partners (NYSE:KMP) yields under 7% without the quality hedge book.

If you're not averse to a company selling cigarettes, Altria (NYSE:MO) may be the most dependable dividend-paying stock in the market today. For decades, this titan has consistently paid a top tier dividend and delivered impressive total returns, year in and year out. Today's yield of 6.5% is among the best and the safest. And with a P/E ratio of 13, shares are cheaper, relative to overall market index.

With a 4.4% yield and a $16 share price, Pfizer (NYSE:PFE) looks very attractive, from both angles. Despite the patent loss on Lipitor in the next couple of years, Pfizer has a lot of drugs in its pipeline, even more so with the recent acquisition of Wyeth. And while you are waiting for this to happen, your earning nearly 5% on your investment. Pfizer is $130 billion company that earned over $15 billion in free cash flow in 2009.

The Bottom Line
Dividends are real, and they can be counted. A stock that yields 4% a year need only appreciate by 5% per annum over the long-run to produce a market-beating return. So, ignore dividends at your own expense. (For more, see Why Dividends Matter.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
  4. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  7. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  8. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  9. Mutual Funds & ETFs

    ETF Analysis: WisdomTree SmallCap Earnings

    Discover the WisdomTree Small Cap Earnings ETF, a fund with a special focus on small-cap and micro-cap stocks with positive earnings.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares US Regional Banks

    Obtain information and analysis of the iShares US Regional Banks ETF for investors seeking particular exposure to regional bank stocks.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  6. Net Present Value - NPV

    The difference between the present values of cash inflows and ...
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>
  6. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!