Prospective investor: What is the sign of a good company?
General answer: Dividends.
Better answer: Companies that recently raised their dividend.

Dividends generally represent a company's financial soundness. If a company has generated cash above what it needs to reinvest in its business, it gives the money back to the shareholders.

However, in this difficult economic environment, companies are subject to abnormal cash constraints and lower aggregate demand for products and services, meaning that dividends can easily be slashed. Standard & Poor's said in February that it projects dividends paid by companies that make up the S&P 500 to slump 13% this year, the worst annual decline since 1942.

Evidence that Standard & Poor's projections are right is already available. Aluminum stalwart Alcoa (NYSE:AA) is slashing its dividend a whopping 82% to raise cash. Many financials have cut their dividends: Wells Fargo (NYSE:WFC), once one of the strongest large banks remaining, whacked its dividend 85%. It's trying to shore up its cash positions and keep its balance sheets intact amid widespread economic uncertainty.

That's why, in this environment, simply looking for stocks with high dividends as a way to make steady returns isn't enough. In fact, I'd be wary of stocks with high dividend yields, as they could quickly come down. Expect the unexpected. Even stocks with incredibly strong dividend histories, such as General Electric (NYSE:GE), are being forced to cut.

But here are six companies that have raised their dividends and also have four- or five-star ratings in our 130,000-member Motley Fool CAPS investor community:

Company

Dividend Increase

CAPS Rating (out of 5)

Coca-Cola (NYSE:KO)

8%

****

Oracle (NASDAQ:ORCL)

Initiated dividend

****

Colgate-Palmolive (NYSE:CL)

10%

*****

Abbott Laboratories

11%

****

Royal Dutch Shell

5%

****

XTO Energy (NYSE:XTO)

4%

*****

Walking the walk
But do the dividend increases actually signify strong underlying businesses? Let's put our screening criteria to the test.

Look at Colgate-Palmolive. The consumer products company recorded an 11% increase in revenues for fiscal 2008, while net income rose 13% for the year. Results also beat Wall Street's expectations. The company says it's gaining market share in the global toothpaste market, and says it expects the declines in commodity prices -- which lifted its cost structure last year -- to benefit the bottom line in the first or second quarter. In short, the underlying business looks good.

Now we'll look at Coke. Earnings increased 10% in the fourth quarter, while case volume grew 4%. The Atlanta-based cola king says it's on track to save $500 million per year from refurbished productivity initiatives by 2011. Again, the underlying business is OK.

Oracle is really an exception. The company is issuing its first-ever quarterly dividend, illustrating that the business-software maker perceives it's going to wade through this recession just fine. Oracle generates a steady $8 billion in cash per year and is sitting comfortably on a cash cushion of $8.26 billion.

Increasing a dividend in today's choppy market signals the strength of a company's underlying business and indicates it will probably come out even stronger when the sun shines again.

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Fool contributor Jennifer Schonberger owns shares of Oracle, but does not own shares of any of the other companies mentioned in this article. The Coca-Cola Co. is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.