How to Invest in Dividend Stocks to Build True Wealth

One of the strategies to building long-term wealth is something we frequently talk about at Money Morning: knowing how to invest in dividend stocks.

Investors need reliable income streams for their portfolios, especially in 2013.

Near-zero interest rates set in place currently by the world's biggest central banks - the U.S. Federal Reserve, the European central banks and the Bank of Japan - look likely to remain in place for the foreseeable future. Sovereign government bond yields in the developed world remain near historic lows and pay below the rate of inflation.

For investors, both institutional and individual, that means the hunt for solid dividend-paying stocks will not end any time soon.

Research has shown that, over the long-term, dividends are the key component to overall returns for investors. Studies from Wharton Finance Professor Jeremy Siegel revealed the stunning fact that reinvested dividends account for 97% of total market performance.

Data from Ned Davis Research showed that, over the past 36 years, dividend stocks have outperformed the rest of the S&P 500 by 2.5% annually. In addition, dividend stocks outpaced non-dividend paying stocks by nearly 8% annually during this period.

How to Invest in the Best Dividend Stocks

Choosing the best dividend stocks is not just a simple matter of looking for the highest yielding stocks.

In fact, sometimes these are the worst stocks to pick. Many times these stocks have a high yield simply because the share price has plunged, not because the company has a high payout.

Here are three of the most important factors that every investor should consider when choosing the best dividend stocks:

  1. The company should have a long history of not only paying steady dividends each and every year, but also of raising the dividend annually.
  2. There needs to be a robust balance sheet - strong cash balance and low debt.
  3. Finally, look for a common sense dividend payout ratio. This ratio is obtained by dividing the dividend per share by the net earnings per share. It makes no sense, for instance, to pay out more than what is earned and having to incur debt to pay the dividend.

This last point is especially important.

If the global economy slows once again, then some companies may not do as well. Their earnings per share may drop or even go negative. This means that investors should try to stick to firms that can weather any cyclical downturn in the economy.

Another example would be a company where conditions have changed drastically in the industry. For instance, perhaps new governmental regulations may affect the healthcare industry or a new technology device may make an older one obsolete (think horses and automobiles in the early 20th century).

Stars in the Dividend Stocks Universe

So now that investors are aware of what to look for, which stocks in particular should investors mull over as possible additions to their portfolio?

Here at Money Morning when we have questions about dividend stocks, we turn to Martin Hutchinson, editor of the Permanent Wealth Investor andour guru on these matters, and he has a list of favorite dividend payers.

He suggests investors start with 'aristocrat' or 'heirloom' stocks. These are companies that steadily grow their earnings and therefore their dividends literally for, in some cases, decades.

Hutchinson says "these stocks should be an important base of any portfolio, especially one used for retirement purposes."

Examples are of these types of companies include: consumer products giant The Procter and Gamble Co. (NYSE: PG), which has increased its dividend every year since 1954; industrial conglomerate 3M Co. (NYSE: MMM), which has a reasonable valuation and increased its dividend every year since 1959; beverage giant The Coca-Cola Co. (NYSE: KO), which added some pop to investors' portfolios by increasing its dividend every year for the last 50 years.

Hutchinson also is a fan of REITs (real estate investment trusts) and energy MLPs (master limited partnerships). These types of companies do not pay tax at the corporate level. This means that these firms can pay out a higher yield safely.

One example of a MLP is TC Pipelines LP (NYSE: TCP). This company transports natural gas in the United States and eastern Canada. Pipeline companies generally have a very steady income stream and therefore a reliable dividend payout.

Dividend stocks are the place to be right now, especially in the current ZIRP (zero interest rate policy) world.

As Hutchinson says, "The road to true wealth starts here."

For more on how to invest in dividend stocks, check out this recent report: How to Find the Best Dividend Stocks

Related Articles: