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3 Keys for Picking the Best Dividend Stocks

You are probably shortchanging yourself if your stock investment portfolio lacks the best dividend stocks in the market. Dividend paying stocks are the Holy Grail in the world of stock investing because they provide you a nice side income for your ownership in the company. More so, the dividends received won't lock you out of gains in the company's share price and earnings. You can think of dividend stocks as stocks that provide you with passive income for as long as you maintain ownership in the company.

However, to paraphrase words from the Orwellian lingo, dividend stocks are equal but some are more equal than others. Not all stocks that pay a dividend in the last quarter will pay a dividend in the next quarter, in the next fiscal year and five years down the road. Hence, it is essential that you know the secret behind how wealth managers and investment bankers choose the best dividend stocks.

1) Long Dividend History

The first key to picking the best dividend stocks is a no-brainer since what you want from dividend paying stocks is consistent (possibly increasing) payment of dividends in the short and long term. The best dividend stocks usually have a long history of paying dividends to their shareholders consistently.

It is hard to pinpoint a specific timeframe or number of years that constitute a "long dividend history". However, the most consistent dividend stocks will most likely have been paying dividends for 5 years or more. It might interest you to know that the best dividend stocks in the portfolio of investors such as Warren Buffet usually have a history of consistently paying dividends for 10, 15, 25 and even 50 years.

2) Fundamentally Strong Business

The second key for picking the best dividend stocks is to ensure that the underlying business has strong and sustainable fundamentals. Strong and sustainable business fundamentals will ensure that the company still finds a way to reward shareholders irrespective the prevailing market conditions. A company without strong business fundamentals is likely to pay dividends only when the economy is buoyant and stop paying dividends when the economy is weak and you actually need the extra money.

A company without strong business fundamentals might be cruising with impressive gains in its share price, increasing dividends and crushing earnings estimates only to fall from its high pedestal without being able to recover. You want to make sure that the underlying business has a strong competitive advantage in its industry, diversified product lines, strong brand recognition, astute management and sustainable growth prospects.

3) Reasonable Payout Ratio Relative to Earnings

Dividend paying stocks usually strive to declare dividends as at when due in order to avoid disappointing investors. For some businesses, the decision not to disappoint investors usually lead to innovations in their product and services to drive growth in the top and bottom lines. However, some other companies usually end up killing the golden geese in their bid to deliver dividends at all costs.

A key to knowing if a dividend-paying stock can afford to pay dividends without hurting the business is to check the payout ratio in relation to the earnings per share. Under normal circumstances, a stock's payout ratio should not exceed 80% of its earnings. Hence, a company that reported earnings of $1.00 per share should not pay a dividend above $0.80 per share.

Occasionally, companies might have extra cash such as income from the divesture of some assets or from the licensing of patents. In such instances, companies might have a payout ratio above 80% of their earnings. Nonetheless, such exceptions do not constitute the rule and you should be wary of any company that is getting into debt in order to pay dividends.

Conclusion

The three points provided above for discovering the best dividend stocks are not absolutes and should not constitute the sole determinants of your stock picking strategy in lieu of conducting your due diligence. However, a consideration of the points enumerated above in addition to your due diligence will ensure that you pick the best dividend stocks every time.

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