Get Thy Yield

Pre

sident Bush's plan to eliminate the tax on stock dividends might upend a lot of received wisdom about investing — like the rule that income investments are best in tax-deferred retirement accounts (stocks with a yield might be better unsheltered) or that municipal bonds are the ticket for tax-free income (preferred stock might win out). The Bush plan could also put steam behind stocks that fell out of favor in the grow-grow '90s: those of mature, slowly expanding businesses with reliable cash flow and a commitment to larger dividends. As for bonds, will their appeal fade or increase? To help focus the issues for investors — and get some well-thought-out stock picks — TIME senior writer DANIEL KADLEC assembled a Board of Money Managers, five top investment pros (see box, right) who share a taste for dividend-paying stocks but are far from unanimous on just how to use them. That's appropriate, because different investors will always have different needs. Listen in on the discussion and see where you fit in.

TIME: Before we get to the Bush tax plan, let's just observe that hell has frozen over: Microsoft pays a dividend. What in the world are we to make of that?

JAMES LOVELACE: Shocking as this news is, it doesn't change our view of the stock. Microsoft's dividend is helpful but nominal [yield: 0.3%]. We're looking for stocks that yield above 2%.

TIME: Wouldn't it pay to buy now — before they start raising the dividend?

LOVELACE: More important is where you buy the stock, and a price-earnings ratio around 30 doesn't make Microsoft a value.

C. KIM GOODWIN: We have been predicting a nominal Microsoft dividend. It doesn't excite us. I wouldn't buy it for yield or because they may increase the dividend. It's still about earnings for them.

TIME: Will other techs fall in line?

LOVELACE: Intel [0.5%] already pays a token dividend. As for others, I think the answer is yes. Traditionally, paying a dividend was an expression of confidence by management. With tech companies, that got flip-flopped. Paying a dividend was a sign of a lack of confidence in future growth. The traditional view is coming back.

STEPHEN BOESEL: The really strong negative related to Microsoft is, it almost guarantees that the proposed dividend-tax cut is going to be pared. There is no way they will let Bill Gates collect $100 million each year tax free.

TIME: This tax-break-for-the-rich argument will be tough to overcome. What might a final version look like?

GOODWIN: Thirty-five million U.S. households receive dividends, and 45% of those have less than $50,000 of total income a year. So it is difficult to paint this as just a tax break for the rich. We are confident that Bush will get at least half of what he wants.

TIME: Would a tax cut really make average investors care about dividends?

MICHELLE STEIN: In the 1970s, three-quarters of stocks' total return came from dividends, but that fell to around a fifth in the '90s. Now, as people are getting older, a lot of them are hurting because dividend yields are so low. As these people move away from risk, they're going to want more of the kind of return that goes into their pockets.

TIME: Isn't some caution appropriate — won't dividends be a fad until investors start obsessing again over capital gains?

BOESEL: The shift to dividends could be very big. Just about any company you can look back at that was a significant buyer of its own shares bought at too high a price. And it is hard to find any big mergers that have worked out. So you come back to what management can control: the dividend. Dividends are back, and don't underestimate the ability of Wall Street to make a theme of it.

TIME: So can we look forward to a wave of new, dividend-focused mutual funds?

GOODWIN: Sure.

TIME: To what extent will the dividend chase drive up stock prices? Is this the market's next big story?

STEIN: That may happen in the short term. But it always comes back to whether a company is any good.

LOVELACE: Let me give you an example — two banks, Citigroup and Bank of America. They both sell at about 12 times earnings. Bank of America pays out 40% of its income, close to a 4% yield. Citi pays out 20% of its income, about a 2% yield. If the tax law changes, perhaps Citi increases its payout to 40%, equal to Bank of America's. Do you expect Citi's price-earnings multiple to double? No. It will still sell on the basis of earnings. Over time, Citi shareholders will benefit from the extra income, but it is not going to change the multiple.

TIME: A high stock yield these days is 2%. At what level is the yield too high, telling you something is wrong?

LOVELACE: You can find good, solid names in the 5% range. But if it is over 6%, the market is expecting a dividend cut.

TIME: What are you doing right now to prepare for dividend mania?

DEBORAH KUENSTNER: We are rethinking companies we already own that could surprise the market by initiating a dividend or raising one they already pay — and getting ready to buy more. AIG [0.3%] pays a small dividend and is in this category. We also like Exxon Mobil. They have a decent yield around 2.8%, but our guess is they would do what would be most shareholder friendly, which is to pay out more in dividends.