Dividends: A Slow Recovery in 2010

What was generally a good year for stocks was a terrible year for dividend-focused investors. In 2009, dividend payouts from the large-cap Standard & Poor's 500-stock index are set to fall $52.6 billion, or 21.4%, from 2008, according to Standard & Poor's projections. In dollars, that is the largest decline ever, and in percentage terms it's the biggest drop since 1938, when dividends fell 38.6%. Adding insult to injury for shareholders: Dividend-yielding stocks tended to lag the broader stock market in the past year, reflecting a market bias toward tech stocks and risky companies—which generally weren't paying dividends to begin with. "What is typically a defensive strategy in down markets turned out to be the wrong way to go," says Keith Goddard, co-manager of the Capital Advisors Growth Fund (CIAOX). Dividend stock strategies are popular among conservative investors seeking consistent income. But the financial crisis robbed these shareholders of billions, as financial firms, particularly banks and real estate investment trusts, slashed payouts. From September 2008 to March 2009, S&P 500 companies stopped paying $65.4 billion in dividends. Of that amount, 68% was due to cuts at financial firms. "The big cuts have really been detrimental to dividend investors," says Mitch Schlesinger, chief investment officer at FBB Capital Partners. Dividend ReboundFor the first time in a while, these investors have reasons for hope. Dividend-watchers like Standard & Poor's index analyst Howard Silverblatt predict dividends will rebound in 2010. The main reason: Companies that used to pay big dividends—like General Electric (GE), Bank of America (BAC), and Citigroup (C)—have already made deep cuts. "The dividends, we believe, will come back, but they're going to be slow" in returning, Silverblatt says. It could be 2013 before dividend payouts return to their previous peak, he says. Optimism about 2010 dividends requires at least some belief that the economy won't get worse and may even improve significantly. "If a company has made it to this point in the economic cycle without having to cut its dividend, I'd say [its chances for] cuts are behind us," Goddard says. But Cliff Draughn, chief investment officer at Excelsia Investment Advisors, is more skeptical. He worries about where the cash for dividends will come from. Companies have maintained payouts by cutting jobs and other expenses as revenues have fallen. In 2010, the economy is likely to remain weak, he says. So, if there is any increase in costs, such as higher health-care expenses or commodity prices, "you're probably going to see more cuts in dividends," Draughn says. Attractive YieldsThe current dividend yield on the S&P 500 is 2.16%. That's low by historical standards. Since 1935, the yield has averaged 3.8%. Current dividend yields are attractive, however, compared with the rock-bottom interest rates now on many bonds and money-market funds. Dividend investors are closely watching banks for signs that the financial sector can start rebuilding dividends devastated by the crisis. Hopes were raised by the recent news that all major banks—including BofA, Citi, and Wells Fargo (WFC)—have paid back federal Troubled Asset Relief Program, or TARP, bailout funds. Banks have profited off low interest rates, and have been setting aside billions of dollars to cover loan losses, Goddard says. Once those loan losses level off, banks may start raising payouts again, he says. Draughn, however, worries about commercial real estate problems looming on bank balance sheets. Banks paid back TARP funds not necessarily because they could afford to do so, he says, but to get out from under federal limits on executive pay. "The reason they paid back TARP was not in the interests of shareholders," he says. The prospects for dividends vary from sector to sector. Schlesinger believes utilities may be able to boost payouts as uncertainty clears up about federal climate change legislation. "There have been political worries," he says, and utilities "have been hoarding their cash a bit." Dividends on consumer discretionary stocks could be hurt by slow sales, Draughn warns. "The consumer is still retrenching," he says. "They're still rebuilding balance sheets." Bright Spot: Consumer StaplesConsumer staples stocks, however, have been a rare success story for dividend investors. In 2009, consumer staples stocks have risen only 13%, compared with a 22.5% rise for the S&P 500 as a whole. But the sector fell less in 2007 and 2008, and its dividend payments have remained generous. Only one consumer staples stock in the S&P 500—grocery retailer Supervalu (SVU)—has cut its dividend, while 33 of 34 actually increased payouts, S&P's Silverblatt notes. As a result, consumer staples is the only sector to offer investors a positive total return (including price appreciation and dividend payments) since the market peak of 2007. Through history, dividends have been an important part of stock investors' total market returns. They offer shareholders income and can help keep stock prices stable. The next few years, however, could require patience from investors eager for income. Dividends may gradually recover, but they're crawling their way out of a very deep hole.

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