By Ben Baden

Some Wall Street banks are expected to begin increasing their dividends in the third quarter

Dividend-paying stocks make up the core of many income-focused investors' stock portfolios. Typically, companies that pay dividends do so to inspire confidence in investors and demonstrate that they have a sustainable business with strong cash flows. What better way to woo investors than by cutting them a periodic check for investing in the stock of their company? For investors, dividends help cushion the blow of steep market downturns, and add to their total return during good times. Today, dividend yields of U.S. stocks are low compared with historical standards, but experts say there are reasons to be optimistic.

"Bottom line: Dividends are doing great," says Howard Silverblatt, senior index analyst at Standard & Poor's. But his enthusiasm comes with a caveat: "as long as you don't go back too far," he says.

So far this year through the end of February, 84 companies in the S&P 500 stock index have increased their dividends, and none have decreased them, according to S&P. Wal-Mart made headlines last week when it announced a 21 percent dividend increase, and seven companies, including Kohl's and WellPoint, have initiated dividend payments -- meaning they're offering them for the first time or reinstating them. Compare that with 13 new dividend payers during all of 2010. The bad news: At this rate, it will be 2013 before dividend payments reach 2008 levels, says Silverblatt. (Total payouts are still down 18.5 percent from 2008.)

That's because many companies -- most notably big banks like JPMorgan and Citigroup that make up a large part of the S&P 500's overall dividend payout -- were forced to cut their dividend payments during the financial crisis. The Federal Reserve is currently weighing whether or not to allow these banks to begin issuing higher dividends again. Silverblatt expects the big banks to begin increasing their dividends in the third quarter of this year.

Recent dividend cuts by big banks means investors must look elsewhere for dividends.

In 2007, financial services companies accounted for 29 percent of the S&P 500's overall dividend payout. As of the end of February, the sector made up only 9 percent of total payouts. Other areas of the market that offer dividends include consumer staples stocks, which make up the largest percentage of total payouts (17 percent), healthcare companies, (13 percent) and industrial companies (12 percent).

While banks' payouts have fallen, dividends have picked up within the technology sector.

"Tech is a big payer in dividends now," Silverblatt says. Historically, tech companies have focused on generating a higher stock price and growing their business, not paying dividends. Microsoft was the first tech company to offer a dividend in 2003, and others, including Oracle, have followed suit. Later this year, tech giant Cisco is expected to begin paying a dividend of between 1 and 2 percent, Silverblatt says, which will add a huge boost to tech-sector payouts. The sector now accounts for about 9 percent of total payouts in the S&P 500.

Yield-hungry investors can use mutual funds to invest in a diversified mix of dividend-paying companies. These dividend-focused funds come in two major forms. Some look for dividend growth instead of high current yields, and seek companies that steadily increase their dividends over time. For example, Richard Helm, manager of the Cohen & Steers Dividend Value (symbol DVFAX), looks for stocks with a history of stable and growing dividends. "Historically, the highest-yielding names in the market generally are such because there's issues with the companies," Helm says. Often, companies facing financial trouble have to lower their dividend over time because it's not sustainable, he says.

Helm, like many dividend-focused managers, is heavily invested in the financial services sector. He says he's waiting for the Fed to give some banks the go-ahead to raise their dividends, many of which are only pennies per share at the moment. "We do expect that we're going to see some pretty significant increases out of a handful of banks this year -- and more next year," he says. Specifically, he sees JPMorgan and U.S. Bancorp raising their dividends in the near future.

But with the S&P 500 yielding only about 1.8 percent currently, other managers say investors must turn to sectors with higher-yielding stocks. "You want to have a combination of high-growth and high-yield [dividend-paying stocks]," says Daniel Peris, manager of Federated Strategic Value Dividend (SVAAX), which currently yields about 5 percent. (Cohen & Steers Dividend Value yields close to the S&P 500 average.) Peris currently favors consumer goods companies, as well as traditionally high-yielding, lower-growth sectors like telecommunications and utilities. Two of the fund's largest holding are Verizon and Duke Energy, both of which yield about 5 percent.


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