How to Invest Through the Worst Year Since 1938

Standard & Poor's is forecasting that 2009 will be the worst year for dividend cuts since 1938, a year that sat amid the throes of The Great Depression. That's sobering -- and scary -- news for any investor who depends on those payments to make ends meet.

Unfortunately, Standard & Poor's may be right. In an ominous sign of things to come, the list of companies that cut their dividends this year includes notable global titans like General Electric (NYSE:GE). Until now, GE had maintained or raised its dividend every year since that fateful one in 1938. With the credit market still in shambles, the odds are pretty good that GE will be joined by other companies looking to conserve cash and avoid defaulting on their loans.

Are they all failing?
Yet even amid what may turn out to be a horrendous year for dividends, not every company is cutting back its payouts. Many are maintaining them, and some are even raising those payments to their shareholders.

Finding top-notch dividend payers is tougher than it has been in generations. To succeed, you need to look beyond the basics of dividend yield and payout ratio and dive deep into a company's balance sheet and debt structure. After all, in a credit crunch, even profitable companies like GE may cut their dividends to preserve capital if they face more maturing debt than they can either pay off or roll over.

It's still worth it
That being said, thanks to last year's market sell-off, stocks have higher yields than bonds for the first time in about 50 years. These days, owning the right mix of strong, well-capitalized dividend payers can both give you more income than bonds and the long run potential for growth that only stocks can provide.

Even if the market continues to falter, you can still profit personally by stocking your portfolio full of those solid dividend paying companies if you:

• Continue to invest new money
• Reinvest dividends you receive along the way
• Focus on those strong companies that are maintaining -- or even raising -- their payouts

You might even see overall dividend income increase, even if your stocks go nowhere or continue to fall.

We're in this together
In fact, it's the way I invest my own family's money. While, like everyone else, we've felt the pain of watching our portfolio fall as the market tanked, our overall dividend income has continued to grow. Here are our personal results for the past few years, as well as our projections for the rest of 2009:

*Estimate based on portfolio balance and year-to-date dividend income as of March 17, 2009.

Like the Beardstown Ladies, these numbers don't reflect our return on investment, but rather the overall year-over-year change in our portfolio's balance and dividend income. A portion of those changes come from new capital we've added along the way. As our investment base has grown over time, however, the reinvested dividends and dividend hikes have had ever larger shares of the effects.

In fact, those dividend hikes and the future income-generating potential of those reinvested dividends are a large part of what's allowing us to project an overall income growth this year. That's true even amid what's expected to be a terrible year for dividends, and even though we own GE stock and are feeling the financial pain of its dividend cut.

The open secret to long-term success
No strategy gets it right 100% of the time. Even Warren Buffett had a lousy 2008. But by consistently looking for and investing in a variety of companies with sustainable and rising dividends, you can set yourself up for success over the long run.

What makes a dividend sustainable? Look for how well the payment is covered by both earnings and the company's balance sheet strength. In general, payout ratios less than 60% reflect a good balance between paying shareholders and retaining earnings for future expansion. Likewise, as long as a company's current assets exceed 1.5 times its current liabilities, it is unlikely to face a near-term cash crunch that would force it to cut its dividend.

Find companies that meet both those criteria and have had the audacity to raise their dividends within the last year, and you get a list of stalwarts like these:

Data from Capital IQ, a division of Standard and Poor's, as of March 17, 2009.

At Motley Fool Income Investor, we know how critical those dividend payments are to your long-term financial health. We've seen the tremendous results that come from investing new money in strong companies with solid payouts, reinvesting dividends, and letting long term dividend growth work its magic.

Of course, these aren't formal recommendations, but they bear many of the most important qualities I look for in dividend-paying stocks and are excellent beginning points for your research.

If you're looking for additional stock ideas to help your portfolio benefit from the tremendous long-term benefits that dividends provide, you can click here to read all about Income Investor's favorite stocks, free for the next 30 days. There is no obligation to subscribe.

At the time of publication, Fool contributor Chuck Saletta owned shares of General Electric, Microsoft, Johnson & Johnson, and Intel. Johnson & Johnson is an Income Investor pick. Intel and Microsoft are Motley Fool Inside Value recommendations. The Fool owns covered calls on Intel. Hasbro is a Motley Fool Stock Advisor pick. The Fool has a disclosure policy.