Concern about a market downturn coupled with the slaughter of income trusts is turning investor attention more and more toward dividend-paying stocks.

And this can only help portfolio performance in the long term. But if that means you expect a quick fix for portfolios by switching to dividend-paying stocks, you will be disappointed. It takes time for the results to show.

Dividends add to total returns, and reinvesting them leverages performance mightily. The compounding effect builds gradually. For instance:

> In the 12 months ended Nov. 30, 2006, the S&P/TSX equity composite index — which measures stocks prices only and is the composite index as it used to be (excluding income trusts) — gained 21.6%. Meanwhile the “total return” version of the index, which reinvests dividends, gained 23.6%.

> Over five years, the dividend effect kicks in. From yearend 2001 to the end of last November, the equity index gained 71%; with dividends reinvested, it gained 87%.

> Over 10 years, the margin of dividends-included growth is greater. The total return index rose 161% during the period vs a 122% gain for capital gains alone.

> The experience gained since the great bull market’s liftoff in 1982 hammers home this lesson. The S&P/TSX composite index gained 863% from then until the end of last November; but with dividends reinvested, the return compounds to 1,705%.

This doubling of the index return bears out the observation that, over time, dividends can provide a large portion of a portfolio’s return. As such, the longer a portfolio includes dividend-paying stocks and the more it reinvests those dividends, the better the cumulative performance.

Notice how the margin of dividend-reinvested returns increases over capital gains: 2% in the past year, more than 3% per year over five years, almost 4% per year over 10 years, and more than 36% per year over 23 years.

The ultimate source for evidence of how dividends boost portfolio returns in the long run comes from Chicago-based research firm Ibbotson Associates Inc. Ibbotson has tracked stock and bond returns since 1925; its research shows that US$1 invested in U.S. large-company stocks in 1925 grew to almost US$98 by yearend 2005. But with dividends reinvested, the US$1 became US$2,658.

Ibbotson has also calculated U.S. stock market returns for 180 years. Beginning with US$1 invested in 1824, the capital gain by yearend 2005 was US$374; with dividends reinvested, it became US$3,177,865.

However, reinvesting dividends is not necessarily an easy thing to do with small portfolios. And even though dividend reinvestment plans do the trick for small inves—tors, that restricts investor choice to companies that offer DRIPS.

Dividends have value in market downturns, by cushioning the impact of capital losses. For example, in 1994 the S&P/TSX composite lost 108 points, a 2.5% drop. But projected dividends for the year were almost $98 (the payout indicated at the beginning of the year for the coming 12 months). As a result, the index’s total return almost broke even, with a drop of 0.2%. And in the years 2001-02, the index lost 2,319 points, but indicated dividends trimmed this loss by 233 points, or about 10%.

Even without reinvesting the income, dividends can add a powerful boost to the performance of an otherwise lacklustre stock. TransAlta Corp. provides an example of this. TransAlta’s dividend has been unchanged, at $1 annually, for years; its stock price has drifted for long periods. Over the five years ended 2005, TransAlta shares gained only $3, or 16%. Add the $5 in dividends it paid in those five years and the total return becomes 38% — more than double the capital gain.

For a stock with rising dividends and a dynamic price rise, dividend leverage is also powerful. For example, Bank of Nova Scotia shares gained $24.54 (adjusted for a stock split) in the five years ended 2005, and shareholders received $4.61 in dividends. The dividends lifted total return for those five years to 135%; the stock price alone gained 114%. IE