If you find yourself always on the hunt for the best dividend-paying stocks for your portfolio, that's because one of the most discussed topics in the past two years has been the search for the right income investments. We all know the story and the problem. The U.S. Federal Reserve has lowered interest rates to basically zero and has made it clear it intends to keep them there for years. The hope is that this eventually spurs the economy and returns us to a state of economic growth. While we don't know how the Fed's efforts will succeed given two more years, we do know that it has created near impossible conditions for investors in search of income.
If you find yourself always on the hunt for the best dividend-paying stocks for your portfolio, that's because one of the most discussed topics in the past two years has been the search for the right income investments.
We all know the story and the problem.
The U.S. Federal Reserve has lowered interest rates to basically zero and has made it clear it intends to keep them there for years. The hope is that this eventually spurs the economy and returns us to a state of economic growth.
While we don't know how the Fed's efforts will succeed given two more years, we do know that it has created near impossible conditions for investors in search of income.
In the early days of zero interest polices it made sense for investors to turn to the stock market. They'd buy the beaten down shares of drug companies, real estate investment trusts (REITs), and other high dividend-paying stocks.
Those who did so in 2009 and early 2010 have done very well as the stocks have appreciated substantially, in addition to providing cash flow from dividends.
Then Wall Street noticed the need for income and the sale machine was cranked up to provide products. Mutual funds, exchange-traded funds (ETFs) and other income vehicles were heavily marketed to the public.
As always the tremendous cash flows generated by the Wall Street commission machine have pushed up prices to the point that most of these dividend strategies no longer make sense for most investors, and share prices have appreciated to the point that they are no longer bargains. It does not make sense for investors to risk a large loss to gain less than a 3% dividend payout.
What does make sense is that investors seeking income should look elsewhere and behave differently than the crowd to achieve their goals.
This means taking the following steps when searching for the best dividend-paying stocks.
How to Find the Best Dividend-Paying Stocks
The first step is to assemble a list of potential investments that will reward you with solid dividend payouts without exposing you to serious long-term capital losses.
You want to find good companies that will be around a long time and are not ridiculously overvalued. You will want your list of stocks to contain those stocks that are not already the favorites of Wall Street.
Using stock screeners and research services you want to build a list of stocks that have good dividend yield of 3% or more at the current price.
You also want companies that have a history of growing the dividend and are likely to increase the dividend at a reasonable rate in the future.
In fact, Money Morning Global Investing Strategist Martin Hutchinson said a company's track record is the key factor in finding a solid dividend-paying stock.
"Specifically, you're looking for companies that have a decades-long record of increasing dividends and providing value to investors," said Hutchinson. "These are stocks that can generate profits like clockwork-even in down markets."
To decrease your exposure to companies that could cut their dividend, limit your candidate list to stocks that pay out less than 60% of net profits as dividends.
Finally you want to avoid the herd so cut any stock that has more than 70% of its shares owned by large institutional investors.
The resulting list of stocks gives you candidates than can reward you with strong dividend payments that should rise in the future. Many of the stocks also have the potential for strong appreciation over the next several years.
One for the Road
An example of a dividend-paying stock meeting this criteria is SJW Corp. (NYSE: SJW).
The company is in the business of production, storage and distribution of water in California as well as parts of Texas. This is an area many believe will be a growth industry over the next decade as water supplies are pressured and prices rise.
The stock yields 3% at today's price and the company has a solid history of raising the payout. You can be ahead of the crowd with this stock as less than 50% of the shares are owned by the large institutions.
Also, just like when grocery shopping, keep your eyes peeled for deals on dividend stocks.
At least once a year we get a period where stock prices decline by at least 10% to15%. Different sectors of the market will decline during the course of the year and offer attractive entry points.
Putting together a portfolio of dividend-paying stocks requires patience, and thinking differently than the herd mentality exhibited by most investors, but it's worth it as you can create a portfolio that grows your wealth over time.
Money Morning's Martin Hutchinson has spent decades perfecting his system for finding the best dividend-paying stocks. Click here to learn more about his method.