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Stocks offering healthy dividends can pay off in tough economic times. But we should be careful of high yields in the financial and utility sectors.
Even if stocks go nowhere this year-a distinct possibility as US recession looms-investors can get returns by hunting for companies that pay healthy dividends. You receive the company's quarterly payouts even if it's stock, and the entire market, heads south. While this is a popular and often successful strategy during bear markets, it also entails some dangers. Watch out for stocks that offer an especially high dividend yield. That could signal that a company might not pay its dividend. For example, since the credit crisis began in July, financial firms have been disappointing investors by slashing dividends.
At the other end of the spectrum, profitable companies with airtight balance sheets often offer pitifully low dividend yields. The other traditional dividend play is the safe, boring utility sector. Heavily regulated, utilities offer slow growth but high, consistent dividends. However, most managers warned of problems ahead for this sector. Utilities have already had a good run and many market observers think the stocks are overvalued. A good place to find healthy dividend yields is the consumer staples sector, where products like food and tobacco provide steady cash even in recessions.
Another necessary product that often sells well even during recessions is health care and pharmaceuticals. However, big pharma faces challenges. It's a tough political environment, with increased regulation of the health-care system. Telecom service providers also offer healthy dividends. These companies pay significant dividends and have strong balance sheets. Energy firms tend to have lower dividends than some sectors, but they're generating huge profits. Because high dividends are often concentrated in particular sectors, fund managers say it's important to diversify. Many dividend-focused investors got burned by too much financial exposure in 2007.
Dividend-paying stocks should continue to be popular in the next decade because of demographic shifts. As baby boomers retire, they'll seek out more stable investments with steady payouts.