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By Jason Stipp and Jeremy Glaser | 12-10-2012 01:00 PM

Dividends Not Just for Retirees

A strong and growing dividend can be a great signal of a quality stock for any kind of investor.

Jason Stipp: I am Jason Stipp for Morningstar.

Dividends have had a great tailwind recently as folks entering retirement are seeking income in a very difficult yield environment, but dividends aren't just for retirees or those seeking an income stream. A dividend can be a great signal of a quality stock for any kind of investor.

Here to talk about why is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: Glad to be here Jason.

Stipp: Dividends have gone through phases where they've been more popular, less popular. They're more popular right now. But why, just beyond its popularity or whether it's not popular, why is a dividend a good thing?

Glaser: Right now there are a lot of structural reasons for their popularity. You have really low yields in the fixed-income market, as people are looking at potentially common stocks in order to fill that income part of their portfolios, and you have a lot more folks retiring who need that income, who are looking for money to pay the bills.

But like you said, even beyond that, dividends can make a lot of sense for people. And I think that the first, and maybe most important one, is total return. Looking over the history of the S&P 500 over a long time, we think that about 40%--give or take a little bit depending on how you crunch the data--of that total return came from dividends and not just from the price appreciation. So, if you ignore dividends, if you only look at stocks that don't pay dividends because you think those are going to grow more or just don't care that much about it, you're leaving a lot of that total return on the table, and that's really what you're looking for as an investor. When you go to sell those stocks, when you go to really look at your portfolio when you need that money, that total return is what's going to get you there.

Stipp: On a fundamental level, dividends also say something very important about the earnings of a company.

Glaser: I think they absolutely do. When we look at stock investing, we've always advocated buying high-quality companies at a discount to their intrinsic value and holding them for a long time, so you can realize the value of that company. And dividends are a good signal that a company does have those potential competitive advantages and that there really are solid earnings and really solid cash flow behind what that business is doing.

If you didn't have that cash flow coming in the door, if it's just accounting profits or maybe a company that just sees sustained losses, they wouldn't be able to come up with that cash to pay out those regular payouts to investors. I think it is a good sign that the company is on a good track--not the only sign you want to look at--but certainly an important one. And particularly if you look at emerging markets, where you're more worried about governance, that dividend can be a sign that there really is good cash flow behind these names.

Stipp: If a company pays a regular dividend and grows that dividend over time, it also says something very important about the management of that company.

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