It’s been purported — and widely reported — that dividend stocks are a crowded trade. If this is true, and to some extent it may be, you can count me in, too.

There are a number of compelling reasons to invest in dividend-paying stocks today. Consider this:

·       US stocks offer income that rivals or outstrips that of traditional fixed income options today, while also providing capital appreciation potential not available from bonds.

·       Dividend-paying companies in the S&P 500 historically have outperformed non-dividend payers and the broader market over the long term, with lower volatility.

·       While the highest-yielding stocks have been overbought and are expensive, high-quality companies with track records of growing their dividends are still available at reasonable valuations.

·       Dividend payouts in the US are lower than their long-term trend and below their international counterparts. This tells us US dividends have room to grow, and we want to own those stocks as they do.

Besting Bonds

For yield-seeking investors, the traditional sources of income simply are not making the grade today. US Treasury yields are at all-time lows on a nominal basis and are even less appealing on a real basis. A 10-year Treasury, with a yield of 1.68% on August 8, will leave an investor with a flat to negative return after factoring in the current inflation rate of 1.7%. Stocks, we believe, offer a much better proposition.

Of the top 50 stocks in the S&P 500, 39 offer a higher current yield than the 10-year Treasury. And many more company stocks are providing yields greater than the same company’s bonds. While future dividends cannot be assured, stocks also offer the potential of income growth over time, whereas bond coupons are fixed throughout the life of the bond.

Proof in the Performance

According to a study from Societe Generale, dividend growth was the single-largest contributor to nominal returns across key developed markets over the past 40 years, providing more return than valuation moves. As a result, dividend-paying stocks have outperformed non-dividend payers — and the broader stock market — over the long term. Through the power of compounding, the benefits of dividend yield and dividend growth become increasingly pronounced over time.

It is also worth noting that, in bear markets, stocks that pay dividends have gone down, on average, about half as much as those that do not pay dividends.Dividend payers historically have outperformed in bull markets as well, affording investors an average of 3% more per year during the last 10 US bull markets.

Quality Matters

Not only have dividend stocks provided relative outperformance over the long-term, but they have done so with less volatility. This is because companies that pay and grow dividends typically are of high quality. They have better business models, stronger balance sheets and a higher degree of confidence in their secular growth capabilities. These characteristics historically have helped these stocks outperform in difficult and volatile times, such as we are experiencing currently. We find that a history of dividend payments is almost self-regulating in that the tacit obligation or responsibility to pay imposes a sort of discipline upon a company.

Quality is also key when it comes to price. While it is true that some of the highest-yielding stocks are expensive today and have been overbought, this is not the crowd we wish to be part of. These higher-yielding stocks tend to be higher risk. We prefer quality companies with a proven ability to maintain and grow their dividends. The high-quality holdings in our portfolio are actually trading at a discount right now as income-starved investors flock to the very highest yields. We believe investors who are willing to forgo a modicum of current yield will be rewarded over time, with less risk along the way.

Room to Grow

Our confidence in the long-term “pay-off” also stems partly from the fact that US dividends appear to have room to grow. Currently, the 30% average payout ratio of companies in the US is about half of the domestic market’s historic average; it’s also less than that of Europe, which is around 40%. Going forward, we expect to see a return to more “normal” payout ratios in the US and, subsequently, an opportunity for investors to collect even higher levels of current income in the future. From our seat, recent trends confirm that US companies have been raising dividends. And indeed, it appears to us that companies have plenty of room to increase dividends further, as they currently are paying out a relatively low percentage of their earnings.

Overall, if the dividend space is a crowded one today, it’s with good reason. It’s also one crowd we don’t mind being a part of, with two key caveats: We want to focus less on current yield and more on the potential for dividend growth, and we will always place high quality above high yield.

Robert Shearer, CFA,is a Managing Director and member of the Fundamental Equity division at BlackRock, where he serves as lead portfolio manager of the BlackRock Equity Dividend Fund. Mr. Shearer’s service with the firm dates back to 1997, including his years with Merrill Lynch Investment Managers, which merged with BlackRock in 2006.

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Investment involves risk. Stock values fluctuate in price so the value of an investment in stocks can go down depending upon market conditions. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are magnified for investment in emerging/developing markets or smaller capital markets.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of August 2012 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

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