The New York Times published an interesting article this week discussing dividends paid by U.S. companies. The author Christine Hauser noted that the increased dividend payout last year is a sign of recovery.

From Dividends Rise in Sign of Recovery:

Companies listed in the Standard & Poor’s 500-stock index paid $240.6 billion in dividends in 2011, up from $205 billion in 2010. The 2011 payout was the largest since 2008, when firms had not yet been hit by the full brunt of the financial crisis and paid a record $247.8 billion in dividends.

Dividends are on track to set a record of more than $252 billion in 2012, according to data released by S.& P. that is based on the current dividend rates of 394 companies. While there could be some changes as the reporting season begins this week, analysts said companies were expected to continue to pay shareholders, possibly at the same rates or higher, as some of the economic and fiscal headwinds from 2011 tapered off.

“Dividends have been rising strongly,” said Binky Chadha, the chief strategist at Deutsche Bank. “And the rise that we have seen has plenty of upside.”

Companies that pay high dividends were some of the best performers in the markets last year.

Telecommunications, utilities and health care shares had the highest yield rates at the end of 2011, at 5.86, 4.13 and 3 percent, respectively.

I agree with the author’s conclusion since dividend payments come out of profits earned and is a strong indicator of a company’s financial performance.

Though it is commendable that U.S. companies are increasing their dividend payouts, they still lag when compared to the payouts of foreign companies. Relative to their overseas peers, U.S. firms hold over one Trillion $ in cash and equivalents on their balance sheets. So much higher payouts are possible.

The current yield on the S&P 500 is 2.08%. At the end of 2011, the yield of the MSCI Index for U.S. stood at just 2.2% compared to much higher yields in other countries as shown in the graphic below:

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Source: Guide to the Markets, 1Q 2012, J.P. Morgan Asset Management

While companies in certain industries in the U.S. have higher yields than the S&P 500, most of the others still hold a significant portion of profits as retained capital for future investment. Invariably these firms squander the funds on share buybacks, expensive acquisitions and other corporate actions due to short-term thinking by the management. In majority of the cases, these actions hurt long-term shareholders. Hence instead of narrowly focused on US firms, investors looking for dividend income should consider investing in foreign stocks. For example, most European companies have a tradition of paying high dividends in two installments per year. Though markets in Europe were crushed last year, excluding financials one can find other sectors which offer higher yields and growth.

Related ETFs:

SPDR S&P 500 ETF (SPY)
SPDR STOXX Europe 50 ETF (FEU)
iShares Dow Jones Select Dividend Index (DVY)
Vanguard European ETF (VGK)

Disclosure: No Positions

Investing in stocks produces the best return especially in the long-term. However when inflation is taken into account the return may not be the highest. Despite the best efforts of the U.S. Federal Reserve to combat inflation, it continues to grow year after. Inflation growth is particularly high in certain service industries such as health care, tax preparation, banking, asset management, real estate brokerage, etc.

The following chart shows the total returns of S&P 500 since the early 1960s with and without adjustment for inflation:

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Source: The scourge of inflation, The Globe and Mail

The total return on the S&P 500 since the early 1960s is an average of 9.6% per year. However when adjusted for inflation, the rate of return falls to just 4.8% per year. Since inflation affects taxes, asset management fees and others, the actual rate of return an investor earned during the period shown in the chart is only 1.3% when those factors are included in the rate of return calculation. Clearly 1.3% per year is not a great return for investing in  stocks.

The takeaway from this post is that investors should diversify their portfolio among various asset classes in order to earn an inflation-adjusted higher return. This would mean investing in stocks (in developed emerging markets), bonds (corporate, municipal and treasury), real estate, CDs, etc.

Related ETFs:
SPDR S&P 500 ETF (SPY)
SPDR DJ Euro STOXX 50 ETF (FEZ)

Disclosure: No Positions