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How Dividends Could Save the Day

December 31, 2012 — The New York Times — By Paul J. Lim    Bookmark and Share

WHEN the global economy slowed last year, investors looking for reasons to be bullish could at least point to one positive sign: the continued strength of corporate profits.

Even as the pace of economic growth in the United States fell to 1.7 percent in 2011 from 3 percent in 2010, profits among companies in the Standard & Poor’s 500-stock index climbed by an estimated 15.8 percent. Revenue, meanwhile, surged by a surprisingly strong 10 percent.

Yet as investors usher in a new year, their faith in the profit outlook is starting to wane — and for good reason. Corporate earnings are projected to rise only around 4 percent through June, and 8 percent for the full year, according to estimates by S.& P. Capital IQ. That’s down from earlier projections of 13 percent growth for 2012.

The recent adjustments to the predictions were to be expected, said Christine Short, senior manager at S.& P. Capital IQ. “There’s a cloud of uncertainty engulfing Europe,” she said, “and analysts don’t know how to position their forecasts.”

There are other reasons to be concerned, said John Butters, senior earnings analyst at FactSet, a financial research firm. “When you look at 2012, the two sectors that are expected to drive growth are financials and technology,” he said.

Mr. Butters said the modest 2012 growth projection for the overall S.& P. was dependent on financial sector earnings climbing by around 25 percent this year. Last year, banks, brokers and insurers collectively saw their profits rise just 6 percent. The forecast also depends on tech sector profits expanding by around 10 percent this year.

“The question is, do people have a lot of confidence that financial companies will perform so well?” he asked. As for technology, Mr. Butters pointed out that one tech leader, Oracle, recently reported worse-than-expected revenue growth, which could be a harbinger of the challenges faced by the broader tech sector as well as the general economy.

Technology revenue growth, for instance, is expected to slow to 7 percent this year from 12 percent in 2011. Similarly, sales growth for the entire S.& P. 500 is expected to slow to around 4 percent in 2012, a sign that the global economic slowdown is starting to seep into corporate results. Global gross domestic product growth is expected to slip to 2.7 percent this year, from 3 percent in 2011, according to IHS Global Insight.

So if investors can’t rely on strong earnings growth or a rapidly expanding economy, what’s left to keep the bulls hopeful?

One possible answer may be dividend growth, market observers say.

“In an environment where economies around the world are slowing, growth is starting to get scarce,” said Thomas Huber, a portfolio manager at T. Rowe Price, “and interest rates are so low, it makes sense to focus on companies that can grow their dividends over time.”

Unlike corporate profits, which rebounded to record levels last year, overall dividends paid by domestic companies have yet to recover fully to the highs reached before the global financial crisis. Yet that could change early this year. S.& P. 500 dividends are expected to grow by nearly 11 percent in 2012, said Howard Silverblatt, senior index analyst at Standard & Poor’s. “The dividend story is good and should continue to be good,” he said.

Yes, there is always the possibility that companies could reverse course and cut their payouts to shareholders. “But if companies cut, forget dividends — that’s a sign that the economy is really shot,” he said.

MR. SILVERBLATT says one reason for continued strength in dividends is that companies are sitting on record amounts of cash. And “companies have been pounding their chests about the importance of dividends, yet the dividend payout ratio is a little under 30 percent,” he said, referring to the percentage of earnings that corporations are passing along to shareholders as dividends.

Historically, he said, the payout ratio has hovered around 50 percent for S.& P. 500 companies.

Low interest rates are another reason that investors are likely to focus on dividend growth. Since 1962, the dividend yield of the S.& P. 500 has averaged about 40 percent of the yield on 10-year Treasury notes. Today, however, the S.& P. is paying more, dividend-wise, than 10-year Treasuries.

In such an environment, market strategists say, investors tend to lean toward dividend-paying stocks. And if corporate profit growth slows as expected, that interest will only grow.

Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com.