This has already been a bumpy year for the stock market. And the volatility is expected to continue as we move from a recovery to some sustainable growth. As a result, Jeffrey Kleintop, chief market strategist for LPL Financial, says people should focus on dividend-paying stocks to ensure returns in a volatile market.
"A focus on yield makes a lot of sense in a low-returning and volatile market place," Kleintop said. "Prices tend to go up and down, but you can at least count on getting that regular dividend payment each quarter."
What's more, after the worst year on record for dividends since 1955, Kleintop says companies are poised to raise or reinstate their dividends. "I think this year will be outstanding in terms of the number of companies and the size of their dividend increases after 2009 was a record year on the downside," he said. As of March 1, 49 companies in the S&P 500 have increased or initiated a dividend this year, including Coca-Cola (NYSE: KO) and Tiffany (NYSE: TIF).
Companies have used cost-cutting, including payroll reductions, to widen their profit margins, equipping them with a lot of cash as the economy comes back. "Companies have the cash flow," says Kleintop. "They've seen revenues grow and they've kept their expenses very low. That extra cash flow has been accumulating on their books and now they have the ability to increase their dividend or even declare a new dividend for many companies that haven't done that."
Look at financial and technology sectors
One sector poised for a comeback is financials. Kleintop says he expects big banks that used to be big dividend payers will go back to paying dividends. Large banks were once the No. 1 sector for dividend payouts. Banks like Goldman Sachs (NYSE: GS) and Wells Fargo (NYSE: WFC) have repaid their TARP loans, and Kleintop says they are now strong enough to pay dividends on common shares again. "As their cash flow bounces back, I think we'll see many of those companies return to a focus on dividends and returning capital to shareholders," he said. "Quality names in the sector like JPMorgan Chase (NYSE: JPM) that cut its dividend certainly stands out as a company in mind that has the room and the ability to increase that dividend going forward."
With the recession, large banks like BB&T (NYSE: BBT) and Bank of America (NYSE: BAC) were forced to slash their dividend -- or in some cases eliminate them entirely -- to shore up their balance sheets. Kleintop says big banks have taken steps to position themselves adequately for the losses they're likely to see. He also says we're likely to see a slower pace of foreclosures moving forward, and hopefully that combination will lend itself to better dividend growth. (However, my Foolish colleague Alex Dumortier notes that these dividend increases may be a ways off.)
But while big banks may be positioned for dividend increases, Kleintop says problems related to commercial real estate and ongoing poor residential loan performance still dog many smaller local and regional banks.
Interestingly enough, technology is also popping up as a dividend-paying sector. Kleintop notes, though, that he doesn't think the sector will be widely known for its high yields anytime soon. "It's still the lowest-yielding sector of the S&P 500, but there were a disproportionately large number of companies that pay out a low or no dividend relative to their earnings and have a lot of cash flow with which to finance those dividends," he said. "So they may seek a new class of investor to their stock by instituting a dividend, or increasing their dividend to become more meaningful."
What it all means
More than reliable returns for investors, dividend payments tend to signal confidence in a way that earnings don't convey anymore. Often companies have moved away from providing quarterly earnings guidance, and Kleintop says he thinks people have to compensate for that and focus more on dividends. "I think a dividend can speak very loudly in this kind of an uncertain environment that a company is confident in its sustained longer-term outlook for growth despite what the next quarter or two may hold."
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