Why dividends still beat buybacks by Scott Cendrowski @FortuneMagazine March 28, 2012, 9:44 AM EDT E-mail Tweet Facebook Google Plus Linkedin Share icons His investment style may be hot these days, but Federated fund manager Daniel Peris views it as the oldest way to play the market. FORTUNE — Daniel Peris is a dividend purist. It’s not just that he hunts for companies able to deliver high returns via dividends. It’s that he views dividends as the fundamental drivers of the stock market. In his view the size of the cash payouts and their rate of growth determine the price investors will pay for a stock over the long run. Sure, the occasional non-dividend payer like Apple (until this year) may shoot to the heavens. But when it comes to predictable returns, he believes the payers win. Since launching in 2005, the $6 billion Federated Strategic Value Dividend Fund SVAAX , which Peris co-manages, has returned 5% a year to beat the S&P 500 (SPX). Using the same strategy in individual accounts, he says, the team has produced 8.7% annualized returns before fees over 11 years. Fortune spoke with Peris, 47, a former historian who studied the Soviet Union, about the dividend stock landscape and the impact of potential tax changes. Edited excerpts: Dividend-paying stocks have excelled over the past few years, gaining attention. Are we in a dividend bubble? There’s now a healthy notion that people should be getting income from the stock market. Until the early 1980s, the U.S. stock market was an investment platform for which you were paid in cash. Over the past couple of decades it’s come off of that. But before that, older people remember buying stocks for their dividends. Now they’re doing that again, for the first time probably in three decades, and some ask if that’s a new paradigm. Well, it’s not a new paradigm. It’s actually a very old paradigm. It’s the original paradigm. Are there dividend-paying stocks that are pricey and areas that are undervalued today? There’s not much cyclicality in the types of businesses we invest in. We entered 2012 with roughly the same valuation metrics that we had in 2011: about a 5% yield and 5% dividend growth rate. Over time that should generate 10% annual returns. What’s cheap, what’s less cheap — we don’t engage in that much. However, we did have some turnover last year. The prices of some utility stocks moved up dramatically ahead of their dividend growth rates. Some were up 20% or 30% or more last year. The yield was no longer satisfactory given the dividend growth. We did trim or take out some of the utilities to reflect that. Verizon, AT&T T , and Vodafone VOD were top holdings at the end of January. Are their dividends growing fast enough to provide those 10% annual returns? Telecommunications services are ubiquitous. There are margin pressures. But there is also consolidation that benefits the companies. They have recurring revenues. And they’ve been able to grow their dividends and yield above 5% today. Then there are the consumer names, which have slightly lower yields but better dividend-growth prospects: food, beverage, household products. Medical names with consumer goods divisions also have a high dividend-growth profile and a slightly lower yield. You own European oil stocks, including Royal Dutch Shell and Total TOT . Why pick those over domestic oil companies? We do own a couple of domestic ones. But I wouldn’t say it’s an assertion that somebody’s oil is better than somebody else’s oil. These are large, diversified, pretty stable businesses. The point is, we get paid more to own these European-listed companies. Where we can get a very, very similar business — you know, integrated energy, large-cap pharma, global food companies — but with a higher payout ratio, a greater dividend, we’re not going to hesitate to lean in that direction. What’ll be the effect of the proposed dividend tax increase from 15% to something like a marginal tax rate for households making over $250,000? I think it’s prudent to assume the tax rate will change. There are two ways to look at that. The first is the impact on the stock market, which is where I have less concern. About half of stocks are held in tax-deferred accounts, so it really won’t matter. And a good portion of those in taxable accounts are held by retirees and middle-income Americans who aren’t in the maximum taxable-income category. They’ll face an increase, but not the 40% rates you’re talking about. I just don’t see people selling this type of portfolio because the tax rate has gone up if they don’t have the ability to get income elsewhere. Where a dividend-tax increase will have a greater impact is corporate behavior. There are a bunch of companies that may pause in their motion toward dividend growth. But I don’t think it will necessarily affect many of the high-dividend payers. They’ve operated under even higher taxes in the past and aren’t likely to change their policy. Why isn’t it better for companies to engage in stock buybacks? Analysis shows how badly timed share repurchases are. Companies buy high and sell low. I would argue that a dollar of dividends, albeit highly taxed, is still a check in the mail. A share repurchase goes off into the ether and never benefits Main Street. It’s just money that could’ve come to you that didn’t. This story is from the April 9, 2012 issue of Fortune.