Top Stocks For 2004

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In the next few weeks, a rash of companies will raise their dividends, joining the ranks of Pulitzer, Oxford Industries and others that did so earlier this month. January and February almost always bring an outsize stream of dividend hikes, as companies lock in the good news ahead of their annual shareholder meetings each spring. This new year's burst could be exceptional. After decades in the dustbin, dividends are once again in fashion in corporate boardrooms, and they deserve a prominent place in your portfolio.

Investing for dividends fell deeply out of favor in the grow-grow 1990s, when the number of companies that pay them declined steadily and the average dividend yield shriveled to just 1.1%. Before this unusual period, an average dividend yield of 3% was considered abysmally low. But with tech stocks in favor and aggressive CEOs reinvesting for earnings growth, the number of companies in the Standard & Poor's 500 that paid a dividend sank to just 351 at the end of 2002 from a peak of 469. This decline reversed last year. An improving economy and a new law that taxes stock dividends at the lower capital gains rate (rather than as ordinary income) prodded a wave of companies to initiate payouts. Dividend payers in the S&P now number 370, and the average yield is 1.6%. Those remain well below historical levels. "We're just turning the corner," says Howard Silverblatt, an analyst at S&P.

Indeed, investors seem barely to have noticed. Stocks with a yield rose just half as much as those without a yield in 2003. For example, General Electric, which yields 2.5%, rose 27% last year — in line with the market average. But Lucent, which pays no dividend and barely survived the recession, more than doubled. Lucent's run has extended into the new year — it's up another 38%--while GE is up just 3%.

Don't let any of that put you off. In the early stages of a bull market, the most speculative stocks — in this case Internet, telecom and other techs that were left for dead in 2002--often get the biggest bounce. But in time, investors migrate to the stocks of proven companies that have been out of favor but are certain to benefit from an ongoing recovery.

This shift could start any day. Clearly, by April investors will realize what a sweet deal dividends are. Roughly $3.7 trillion of the S&P 500's $10.3 trillion market value is held by individuals in taxable accounts. These shareholders will reap tax savings of $13.6 billion this year. Some, and maybe even much, of that windfall will be reinvested in dividend-paying stocks. Meanwhile, the sheer size of the savings — it equals the total amount of child-credit checks the government issued last summer to stimulate the economy — will call attention to dividends.

So, as you think about where to deploy assets this year and beyond, save room for dividend payers. Byron Wien, market strategist at Morgan Stanley, predicts that a surge in the prices of stocks with a yield will be one of the big surprises of 2004 and that the year's winners will include Pfizer, Wyeth, Bristol-Myers, GE, Microsoft (it started paying a dividend last year), Coca-Cola and Altria. Any number of mutual funds focus on dividend payers. Among the best are Fidelity Dividend Growth, T. Rowe Price Dividend Growth and (if you invest through a broker) Capital Income Builder from the American Funds group. Don't bet too much on any one theme. Keep large-and small-cap stock funds, junk bonds, real estate, foreign stocks and Treasuries. But dividend payers should trump them all.