One of the many potential aspects of the Fiscal Cliff is the taxes on dividends rising from 15% to nearly 40% in most cases. Should that happen, the net take for investors in dividend stocks will decline, suggesting the value of that dividend and the underlying stock will fall in value.
For example: Dupont (DD) pays an annual dividend of $1.72, giving the stock a yield of 3.9% at current levels. Taxed at 15% investors after tax dividend amounts to $1.46 or 3.3%. If the tax rate on dividends rises to the maximum level of 39.6%, the after-tax take drops to $1.05, a yield of only 2.3%.
The math is easy, but the question for portfolio managers like Barbara Marcin, head of the Gabelli Dividend Growth Fund (GABBX), isn't whether to sell dividend stocks ahead of the possible tax increase? Marcin says "no" because yield is only part of the equation. "I wouldn't recommend buying a stock just for its dividend anyway," she tells me. By Marcin's methodology she wants growth with her yield. The payout is just a kicker.
"Even if the tax rate goes higher you're still getting a better after tax return on a lot of the dividends than is available to you on fixed income investment," she says. For that you can blame the Federal Reserve which has intentionally driven down borrowing costs to the point that earning interest on anything less risky than a Power Ball ticket is all but impossible.
For investors with a balanced portfolio and Marcin's sensibilities, the potential tax hike of dividends is little more than another headache in a rising tax environment. The yield on all qualified dividends will drop in synch, meaning shareholders have the same options for buying stocks as they did before the hike.