Will expiration of Bush-era tax cuts derail dividends?

The looming expiration of the Bush-era tax cuts could throw a wrench into some dividend-investing strategies, according to Henry Sanders, manager of the $230 million Aston/River Road Dividend All Cap Value Fund Ticker:(ARDEX). While Mr. Sanders doesn't think the anticipated January dividend tax hike to ordinary income from the current 15% level should derail a commitment to dividends, he is concerned that “the tax tail might start wagging the dog.” “We went back and looked at the [positive] impact on dividend stocks when rates were cut in 2003, and it was only about 3% to 5%, which is not that significant,” he said. However, while overall valuations of most dividend-paying stocks adjusted only slightly after dividend taxes were reduced as part of the Bush administration's tax cuts, Mr. Sanders said, the policy did spark a lot of new dividend activity. For example, notable names such as Microsoft Corp. Ticker:(MSFT), Intel Corp. Ticker:(INTC), and Waste Management Inc. Ticker:(WM) made major changes toward higher dividend payouts after the taxes on dividends were cut. “A company's dividend policy provides tremendous insight into what management is doing,” Mr. Sanders said. “I think it would be hugely problematic if the higher taxes drove companies to start forgoing dividend payouts.” In the meantime, Mr. Sanders plans to continue managing his portfolio of more than 70 stocks by looking beyond many of the traditional large-cap names. “Most income-paying dividend funds tend to be large-cap-value-oriented,” he said. “But we're all-cap value, and that means we're finding a lot of smaller companies that pay dividends.” According to Mr. Sanders, who won't invest in any company unless it is paying at least a 2% dividend yield, smaller companies that pay dividends outnumber large-cap dividend payers by a ratio of about 4-to-1. “The weighted average dividend yield is 35% to 50% higher in the small-cap space,” he said. “Plus, on an appreciation basis, small-caps tend to outperform large-caps.” The portfolio currently has a 47% large-cap weighting, 35% mid-cap and 18% small-cap. One example in the small-cap space is Cracker Barrel Old Country Store Inc. Ticker:(CBRL), a longtime dividend payer with a $1.1 billion market cap and a 1.7% dividend yield. Another strong dividend payer that doesn't get a lot of attention is McCormick & Co. Inc. Ticker:(MKC), which has a $5.2 billion market cap and a 2.7% dividend yield. Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives.