The last two years have caused investors in dividend stocks a great deal of pain. Yet even as the stock market has shown an impressive rally, the news on the dividend front continues to be extremely negative.

A recent report from Standard & Poor's noted that out of the thousands of stocks it tracks, only 233 increased their dividends between April and June. That's a record low over the 50-year period during which S&P has tracked dividend information. It's also less than the 250 stocks whose dividends fell during the second quarter.

The impact on investors
Obviously, dividend cuts have a huge impact on shareholders in those companies. Often, investors are attracted to dividend-paying companies whose shares have dropped in price, tempting bargain-hunters with their above-average dividend yields. Yet if the company's business deteriorates so much that the company can no longer pay those dividends, the resulting exodus of current owners often causes shares to fall even further, creating big losses for shareholders.

However, the explosion in the number of dividend cuts has called the entire investing strategy of pursuing dividends into question. With even longtime dividend stalwarts like General Electric (NYSE:GE) and Dow Chemical (NYSE:DOW) admitting defeat and cutting their payouts, it's difficult to have confidence that any company's dividend is completely safe.

Moreover, given the continuing difficulties in the economy, hoarding cash remains an attractive way for companies to build a safety net. In this environment, no company wants to risk not having enough cash to keep operating if last year's credit crunch repeats itself. If that means cutting dividends, then companies have never had a better reason to do so.

Don't give up
However, not all of the news on the dividend front is bad. There are several reasons why you shouldn't give up on dividend stocks:

  • Some stocks are still raising dividends. Dividend cuts get the biggest news coverage, but plenty of companies have continued streaks of raising dividends in 2009. Just in the past quarter, the following companies have chosen to extend their histories of higher dividend payments:

Stock

New Dividend Yield

Consecutive Dividend Increases

Target (NYSE:TGT)

1.7%

37 years

PepsiCo (NYSE:PEP)

3.2%

37 years

IBM (NYSE:IBM)

1.9%

9 years

Johnson & Johnson (NYSE:JNJ)

3.3%

46 years

General Mills (NYSE:GIS)

3.2%

5 years

Source: Yahoo! Finance, DividendInvestor.com.

  • If you've made it this far ... After a year and a half of recession, most companies in the worst financial condition have already cut their dividends. Those that remain have every incentive to maintain their reputations by sustaining their current dividends.
  • Alternate financing available. Moreover, the recent rally has pulled stock prices out of the basement, giving many companies the chance to raise cash by making secondary offerings of new shares. Although issuing new shares dilutes existing shareholders, it avoids the enduring stigma of a dividend cut.
  • A recovery should end the crisis. When the economy starts to recover, just seeing the light at the end of the tunnel should convince many companies that the worst of the cash crunch is over. That in turn will encourage those with hoards of cash to return value to shareholders through dividend increases, and companies of more modest means to maintain their current payouts.

Dividend cuts are always a threat, given that even the biggest companies can suddenly find themselves in financial difficulty. But that doesn't mean you should give up on dividend investing entirely. As long as you're careful to choose the most stable, least risky dividend-paying stocks you can find, your portfolio should survive to see the end of the dividend crisis.

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Fool contributor Dan Caplinger plans to make dividends a big part of his own economic recovery plan. He owns shares of General Electric. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy keeps paying out great information to you.