THE dividend is back. Of course, it never really went away, but during the heady bull market days of the late 1990s and early 2000s the role of the dividend was shoved firmly to one side.

The dividend yield on shares has risen sharply in the past five years — from about 2.5 per cent to about 3.5 per cent — and that has left dividends contributing a larger proportion of total investment returns.

During recent periods of falling share prices, dividends provided the few shafts of light in an otherwise dark and gloomy investment firmament. The rise in the dividend yield, however, owes much to declining share prices, since yield is dividend payments expressed as a proportion of share prices. What is more interesting is that the absolute amount of dividends paid is rising so strongly.

About £46 billion a year is now being paid out to the owners of shares in UK-listed companies, according to Thomson Financial Datastream. In 1999, the equivalent figure was £35 billion. That equates to 30 per cent growth over a period when the cost of living increased 16 per cent.

At the same time, the average annual rate of dividend increases is now growing very strongly. Dividends, on average, grew at more than 10 per cent in 1999, but the rate slipped steadily in the following three years. Between 2001 and 2003, the total amount paid out was more or less unchanged and for brief spells the annual change in dividend payments was negative.

Now, however, dividends are growing at the remarkable annual rate of 12 per cent. It is the best rate seen since 1999, but just as startlingly, the current 12 per cent rate compares with 4 per cent growth registered this time last year.

The rediscovery of the dividend is, by and large, very welcome. Dividends work to shareholders’ benefit in a variety of different ways. Yes, they provide a stream of hard cash, which always comes in useful, but they also impose a discipline on boards of managers. Boards, who know that one of their first responsibilities is to see that the company pays its dividend, can be expected to take an assured approach to the tricky act of balancing riskiness of business decisions with the rewards they might bring.

Take too few risks and the business may wither and be unable to sustain dividend payments. Take too many risks, though, and a company’s income-paying prospects could be undermined in similar, if not more precipitate, fashion.

Dividends are also the shareholder’s friend because they form one of the most reliable methods of valuing shares. Dividend yield statistics allow investors to compare the value of different shares in the same sector and different shares in different sectors. They also allow investors to make decent comparisons with investments in other asset classes, notably bonds and property.

Moreover, it is through the delivery of increased dividends that shareholders can expect to see growth in the capital value of their equities. In some respects dividends are the real underlying profits of a business, since every kind of surplus is either applied to meeting liabilities or is reinvested in the business to secure the ability to pay future dividends.

A company that follows a sensible dividend policy can also deliver smoothed returns to investors. If wider market conditions make life hard for a year or two, the sensible board can ease investors’ pain by maintaining dividend payouts. If pre-tax profit is the only benchmark, the capital value of shares will swing with much greater degrees of volatility.

But some danger lurks where the renewed enthusiasm for the dividend lies. The danger is that boards, perhaps newly aware of the power that dividend payments exert over the capital value of shares in their company, become too generous with dividend payments. Investors, having made similar discoveries, may put pressure on boards to pay imprudently generous dividends. Unsustainable dividends will create value that is wholly illusory. Investors must be wary of reckless dividend payers.