INVESTORS: Investors are focusing on ability to pay dividends and to increase these payments. It is likely this trend will accelerate.

The cumulative impact of three years of declining share values is now beginning to affect the mindset of most investors. Expectations regarding prospective long-term returns have now ratcheted down very substantially.

There are now very few investors who expect equity markets to be able to deliver annual returns of 15 per cent plus and indeed many respected analysts now expect long-term equity returns to come in well below 10 per cent per annum. In fact, many investment analysts and consultants are now assuming future long-term average annual returns from equity markets of about 8 per cent.

Increasingly the decade of the 1990s, when equity markets regularly produced annual returns of 20 per cent or more, is being seen as an exceptional period.

During the 1990s many investors focused almost exclusively on capital gains. The income return from shares in the form of dividends seemed almost irrelevant in the heyday of the 1990s bull market.

Many companies took advantage of this environment and reduced the proportion of earnings that they paid out as dividends to their investors. However, in an environment of much lower capital appreciation, dividends account for a much higher proportion of the total return produced by company shares.

For example, the prospective dividend yield on the FTSE 100 index is now close to 4 per cent. Therefore, if equity markets produce a total return of 8 per cent per annum, fully one half of the return to investors from equity investment will come in the form of dividend payments.

Already investors are beginning to focus on a company's ability to pay a dividend and to increase that dividend payment over time. It is likely that this trend will gain momentum in coming years.

One sector of the market that should benefit from this is the financial sector. Banking and insurance stocks have traditionally maintained a dividend yield above the market average. Historically, financial stocks have been viewed as being less risky than average.

In the past year, this assumption has had to be reassessed as many insurance stocks have suffered from sharp declines in the value of their equity portfolios.

This has been particularly true of UK financial stocks where the share prices of most insurance companies have fallen precipitately over the past 12 months. In addition, the share prices of those banks with substantial life assurance subsidiaries have also suffered.

In practice, many quoted financial stocks have proved to be just as volatile and risky as many other sectors of the equity market.

In contrast, Irish quoted financial stocks have so far avoided many of the problems that have beset many UK and European stocks. The prime reason for this is that the Irish quoted financial sector has limited exposure to falling equity markets.

Even Irish Life & Permanent, which has a very large life assurance business, has been able to limit the damage inflicted by the prolonged bear market.

This is because virtually all of its life assurance business is in unit-linked products where the customer accepts full exposure to market movements. Therefore, falling asset values have only an adverse impact in terms of lower fee income and the company's balance sheet remains secure.

The low exposure of Irish quoted financial stocks combined with ongoing growth in the economy has meant that the Irish sector has outperformed the European average by about one-third over the past year. Continued growth in earnings and dividend payments has underpinned the share prices of Irish financials.

As a result, Irish financials at current share prices still offer good long-term value. The price-earnings ratio (PER) of the Irish sector averages 10.8 compared with 12.6 for the UK sector and 14.1 for the European sector (see table). The dividend yield of 3.3 per cent is somewhat lower than that available in the UK and Europe. However, there are several UK and European companies that have announced future cuts in their dividends.

Barring major unforeseen adverse events, all of the quoted Irish financials seem well capable of growing their dividend payments over the medium term. The third valuation measure referred to in the table is share price to book value. The share prices of the Irish financials are trading at 2.5 times the book value per share which is more or less in line with the norm in the UK and Europe.

Therefore, in terms of the standard investment valuation yardsticks, the Irish quoted financial sector stacks up quite favourably compared with its UK and European peers.

Even allowing for a slowdown in the pace of Irish economic growth, the Irish financial sector seems likely to continue to outperform comparable UK and European companies for the foreseeable future.

Therefore, in the current cold investment climate, the Irish banks offer some sound long-term investment potential.