BusinessWeek has an article Dividends: The Sweet Spot which explains how dividend stocks can provide good returns in a volatile market.

Stocks offering healthy dividends can pay off in tough economic times. But be careful of high yields in the financial and utility sectors by Ben Steverman

Even if stocks go nowhere this year—a distinct possibility as a recession looms—investors can get returns by hunting for companies that pay healthy dividends. You receive the company's quarterly payouts even if its stock, and the entire market, head south.

While this is a popular and often successful strategy during bear markets, it also entails some dangers. Watch out for stocks that offer an especially high dividend yield. That could signal that a company might not pay its dividend. For example, since the credit crisis began in July, financial firms have been disappointing investors by slashing dividends.

At the other end of the spectrum, profitable companies with airtight balance sheets often offer pitifully low dividend yields.

Good Bets
So where's the dividend sweet spot? We asked fund managers to name companies with healthy dividends but without too much risk, and where they're putting their money.

Some fund managers think that long-term investors can find some opportunities in the beaten-down financial sector. Dan Genter of RNC Genter Capital Management said his funds own U.S. Bancorp (USB), Wells Fargo (WFC), and Bank of America (BAC). He believes those big banks "are going to be the survivors" from the credit crisis, but their share prices could be in for a rough ride. If you can afford to wait out the crisis, the stocks' yields—5.5% for U.S. Bancorp, 4.4% for Wells Fargo, and 7% for BofA—can make waiting worthwhile over the next year or two, he says.

But you must tread carefully in the financial sector given the gloomy credit climate. "Land mines are very easy to find in the financial area," warned Kirk Mentzer, manager of the Huntington Dividend Capture Fund.

Some investors worry that financial firms are still paying out too much in dividends. Matt Kaufler of the Touchstone Value Opportunities Fund noted that Citigroup (C) offered a great yield last fall, but the bank soon had to cut its dividend and raise billions in extra capital. Now, with a dividend yield of more than 6%, Citigroup may need to do the same again if credit markets don't improve, some analysts warned.

Stock Staples
The other traditional dividend play is the safe, boring utility sector. Heavily regulated, utilities offer slow growth but high, consistent dividends. Kaufler owns Dayton Power and Light (DPL), with a dividend yield of 4.4%.

However, most managers warned of problems ahead for this sector. Utilities have already had a good run and many market observers think the stocks are overvalued. Many utilities will need to spend heavily on upgrading infrastructure, says Steve Neimeth, a portfolio manager at AIG SunAmerica. Also, they could face increased environmental regulation, especially if the next President tries to limit global warming.

A good place to find healthy dividend yields is the consumer staples sector, where products like food and tobacco provide steady cash even in recessions. Several managers mentioned Altria Group (MO), which offers a dividend yield of 4%. Altria is changing its name back to Phillip Morris and spinning off its international businesses later this month.

High on Energy
Elsewhere in consumer staples, Neimeth owns General Mills (GIS) and Anheuser Busch (BUD), which both have 2.9% dividend yields.

Another necessary product that often sells well even during recessions is health care and pharmaceuticals. However, big pharma faces challenges. It's a tough political environment, with increased regulation of the health-care system more likely in the U.S. In the meantime, companies like Pfizer (PFE), with a 6% dividend yield, are trying to develop new blockbuster drugs to replace the patents they will lose in coming years. Despite this, John Nichol, senior portfolio manager at Federated Investors (FII) says he owns Pfizer. Nichol said Pfizer's strong cash flow means it will be able to keep up its high dividend for at least the next few years.

Telecom service providers also offer healthy dividends. Nichol owns AT&T (T), with a 4.6% yield, and Verizon Communications (VZ), with its 4.9% dividend yield. These companies pay significant dividends and have strong balance sheets, Nichol says. "Yes, they have sensitivity to the economy, but they don't have sensitivity to the credit crisis," he says.

Energy firms tend to have lower dividends than some sectors, but they're generating huge profits. Mentzer likes Chevron's (CVX) 2.7% dividend yield and ConocoPhillips' (COP) 2.4% yield.

Tax Considerations
Fund managers also say they have bought stock in industrial firms, looking for dividend payouts that will hold up thanks to the strong demand for U.S. exports due to the weak dollar. Nichol owns 3M (MMM), with a yield of 2.6%. Paul Alan Davis, portfolio manager of the Schwab Dividend Equity Fund, owns R.R. Donnelley (RRD), a printing firm with a dividend yield of 3.5%.

Because high dividends are often concentrated in particular sectors, fund managers say it's important to diversify. Many dividend-focused investors got burned by too much financial exposure in 2007.

Dividend-paying stocks should continue to be popular in the next decade because of demographic shifts. As baby boomers retire, they'll seek out more stable investments with steady payouts. But changes in tax laws could make dividends less lucrative. The Bush Administration tax cuts, which include a reduction in the rate on dividends, are set to expire in 2010, and it's not clear whether they will be extended.

One fact should hearten dividend-focused investors: Company boards will only cut dividends as a last resort. "There's quite a backlash toward companies that cut their dividends," Davis says.

While there's no such thing as an entirely safe dividend, stocks with healthy yields are a good place to park money in turbulent times.

The Div Guy owns shares of USB, BAC and PFE at the time of this post.