Dividend stocks hang on to the cash Investment managers have touted equities that pay solid dividends as a prudent bet given the meagre returns on offer from bonds. But such stocks have lagged this year's wider rally in equities as companies have hoarded cash. Dividend pay-outs, while rising, have failed to match this year's strong rally in the benchmark S&P index - which is up 8.2 per cent - and sits just shy of last April's post-financial crisis peak. Since the start of 2012, so-called "dividend aristocrats," companies that have increased their pay-outs for the past 25 years, have lagged the S&P with a rise of 4.9 per cent. That comes after they strongly outperformed the broad benchmark's flat performance last year with a gain of 5.7 per cent. With interest rates anchored at historic lows, the question now is whether companies will hand that cash to shareholders in the form of higher pay-outs. Investors, for example, are waiting to see if Apple, which sits on nearly $100bn in cash, could issue a dividend for the first time. "We think 2012 will be the year that dividends grow faster than earnings," said Chris Leavy, chief investment officer for US equities at BlackRock. Dividend growth has lagged substantially behind earnings growth. S&P 500 companies are paying out just 30 per cent of retained earnings through dividends, the lowest pay-out ratio since records began in 1871, according to analysis by Wells Fargo. Similarly, share repurchases, another way to return capital, have increased rapidly since 2008 but, at 35 per cent of profits, are still well below their historical ratio, according to BlackRock. Many analysts expect dividend pay-outs to improve in the coming months as the S&P consolidates on a rebound of more than 20 per cent since last October. Jack Ablin, chief investment officer at Harris Private Bank, says 74 per cent of S&P companies are expected to raise dividends this year. He believes dividend-paying stocks will catch up with the rally in more growth-orientated companies that do not pay a dividend. "Dividend-paying companies will take more of a leading role as the rally matures," he says. And, though some analysts have warned of the danger of "overpaying for quality" following last year's share price gains for dividend payers, a popular defensive strategy amid considerable financial turmoil, investor inflows have shown little sign of abating. Investors pumped more than $8bn into the two most popular exchange-traded funds that targeted dividend-paying stocks in the S&P 500 in 2011. So far this year the S&P Dividend ETF has taken in a further $472m and the Vanguard Dividend Appreciation ETF another $780m. "The attractiveness of dividends to investors was not a one-year fad, it's a generational play," says Gina Martin Adams, an equity strategist at Wells Fargo. The US has an ageing population, which uses the stock market to save for retirement, and those investors are aware that the S&P 500 has not delivered capital gains over a one, five or even 10-year timescale. With the Federal Reserve committed to keeping interest rates at very low levels until at least 2014, subdued Treasury yields are likely to provide long-term support for stocks. The 10-year yield of 2 per cent sits below the dividend yield of 2.2 on the blue-chip-heavy Dow Jones Industrial Average. Barry Knapp, chief US equity strategist at Barclays Capital, notes that prices of the 100 S&P 500 stocks with the highest dividend yield outperformed the 100 with the lowest yields for six consecutive years after 1945, the last time the Fed explicitly capped interest rates. "History suggests that high-yielding stocks could continue their period of strong relative price performance until the Fed policy normalisation process begins," Mr Knapp says. Equally, though, some believe that the tendency of companies to hoard cash is unlikely to abate, even if stock buyers" memories of last year's volatility, as the eurozone crisis intensified, starts to fade. Marc Zenner, head of corporate finance advisory at JPMorgan Chase, attributes this in part to companies" increased earnings outside the US. "These earnings are trapped offshore and therefore not as easy to distribute as onshore earnings," he says. Even with strong domestic cash generation, companies are leaning towards conservatism, anxious to avoid falling victim to another credit crunch should there be a repeat of the global financial crisis of 2008-09. "Chief financial officers are vowing never, ever, to let the credit markets determine whether their operations shut down or not," says James Swanson, chief investment strategist at MFS. On balance, though, Mr Swanson says chasing dividends is probably the best strategy for now. "It's backed up by sustainable free cash flow, and we are still in a yield-starved world," he says. Additional reporting by Michael Mackenzie