By Jonathan Burton, MarketWatch
SAN FRANCISCO (MarketWatch) -- Dividends are coming back in style with investors and they're not just for widows, orphans and coupon-clippers any more.
The tumultuous first quarter of 2009 was the darkest ever for dividends, with more companies slashing payouts than raising them. Dividend-paying stocks have also lagged their non-paying peers in the rally since March 2009.
Dialing into dividend growth
Cash-rich companies are increasingly sharing the wealth by giving stockholders larger dividends. Harry Domash, publisher of the Dividend Detective Web site, highlights several attractively valued stocks with equally attractive dividends that investors can consider now. He talks with Money & Investing editor Jonathan Burton.
Now dividend-paying stocks are being seen in a brighter light. U.S. companies are generally in much better financial shape due to sharp spending cuts in the recession and improving sales as the economy has recovered -- and management increasingly is choosing to share the wealth.
Paying it forward
So far this year, 98 companies in the Standard & Poor's 500-stock index /zigman2/quotes/210599714/realtime SPX -1.90% have boosted their quarterly dividend, including bellwethers Exxon Mobil Corp. /zigman2/quotes/204455864/composite XOM -2.84% , International Business Machines /zigman2/quotes/203856914/composite IBM -1.18% . Procter & Gamble Co. /zigman2/quotes/202894679/composite PG -2.98% , and Johnson & Johnson /zigman2/quotes/201724570/composite JNJ -2.39% .
In addition, seven S&P 500 companies have initiated a dividend in 2010, reflecting confidence in their future earnings ability, according to S&P. These include Carnival Corp. /zigman2/quotes/202325446/composite CCL -2.97% , Marriott International Inc. /zigman2/quotes/200170042/composite MAR -2.13% and Host Hotels & Resorts Inc. /zigman2/quotes/201760234/composite HST -4.38% , and technology firms Tellabs Inc. and Broadcom Corp. .
The large-cap S&P 500 currently yields a bit shy of 2% annually, while dozens of well-regarded companies are even better income providers. The consumer and health-care sectors are particularly dividend-rich, as are the traditional sources utilities and telecommunications sectors. The notoriously stingy technology sector is being more generous with its cash; for example, shares of Microsoft Corp. /zigman2/quotes/207732364/composite MSFT -1.79% yield about 1.7%; Oracle Corp. /zigman2/quotes/202180826/composite ORCL -2.37% yields about 0.8%.
(Banks, of course, used to be reliable and substantial dividend producers, but the market's meltdown ended that. The financial sector's outlook is improving, but don't look for dividends to play a major role in the immediate future.)
Moreover, dividends have always reflected a significant part of stock investors' total return. That's especially appealing nowadays; after two crushing market meltdowns in less than a decade and a recent rise in market volatility, investors see dividends as steady cash givebacks they can count on every three months.
"The climate is very positive for dividend stocks," said Harry Domash, publisher of DividendDetective.com, a dividend-stock website. "A year or so ago it was about finding stocks that weren't going to cut their dividend and go out of business; now it's about finding high-yielding stocks in good sectors."
More than yield
Stock dividends in fact have become attractive bond alternatives, with their predictable and often higher income stream, plus the potential for price appreciation. But stocks typically are riskier than bonds and smart dividend investors know there's more to this strategy than simply buying the highest-yielding names -- tempting as that may be in today's low-yield environment.
A stock may have a fat yield because its business is in trouble. If a company's cash flow can't cover its dividend, that payout almost certainly will be on the chopping block -- with a corresponding hit to the shares. Sometimes the cash flow will be adequate but the business doesn't have terrific growth prospects; in that case you can expect income but not much in the way of capital gains.
Steer clear of these "dividend traps" by investing in companies that have regularly hiked their dividends year after year, preferably for decades. Look also at cash on the balance sheet, earnings-growth history and the quality of the business, all of which support a company's ability to keep increasing its payout.
"Focus on companies that are consistent growers and have strong competitive advantages," said Bob Millen, co-manager of the Jensen Portfolio /zigman2/quotes/200918620/realtime JENSX -1.94% . "Then you lessen the risk that you're going to get in the trap of buying a company that might cut its dividend." Millen follows that rule; Jensen has a strict policy of investing only in companies with return on equity of at least 15% for 10 consecutive years.
Such strong, disciplined approaches to dividend investing have the twin benefit of enhancing your portfolio's yield and controlling risk.
"A dividend is not going to make a bad business into a good stock," said Josh Peters, editor of Morningstar DividendInvestor, a newsletter from investment researcher Morningstar Inc.