Dividends do matter—not exactly a concept we embraced during the boom of the late 1990s!

Dividends provide several benefits often overlooked by investors. An investor emeritus who remembers buying stocks in the 1930s will tell you stocks were once valued by the dividends they paid. They used a price-to-dividend instead of a price-to-earnings valuation method.

Since dividends have to be paid from hard cash, dividends represent real earnings. For a number of years, dividends were out of favor with growth companies, whose strategy was to reinvest corporate earnings back into the enterprise. This led to the abuses now being played out in the nation’s courtrooms where former corporate executives are being held accountable for manipulation of earnings and other accounting scandals.

Corporations paying dividends are being forced to exercise better capital discipline, which, in the long run, should result in better-run businesses. Balance sheets should improve as management will be forced to make better decisions regarding the use of shareholder assets.

During the last decade, the emphasis for stock valuation has been on the price/earnings multiple. Since the real value of any investment is the stream of future cash that will come to an investor (discounted for time, opportunity cost of funds and risk), our unusually low interest rate environment makes stock P/Es unusually high. If interest rates increase, P/Es are likely to come down, bringing stock prices with them. This all adds up to making a case for dividends.

Owning the stocks of companies that have consistently shown their ability to grow earnings and increase their dividend payouts is not unlike owning pieces of investment real estate—rents are collected periodically, and when the property is sold, the price is a function of the earning potential of the enterprise. The best part of this analogy is that stocks like these that are held for a long period in which the investor collects “rent” in the form of dividends do not have to be watched minute by minute on CNN.