Investing in blue chip companies with high dividends can lead to stronger portfolio returns. But there are key factors to watch for to help you pick the best of them

Although we think the best blue chip companies with high dividends are worth holding on to pretty much indefinitely, we keep a sharp eye on them. After all, they are subject to the usual risks. Competitors can overtake them. Expected contracts can fall through. They can lose key employees, run into union or regulatory problems, and so on.

Of course, nobody can predict the future. We’ll change our view and sell some stocks as time passes. We’ll give up on some way too early, and hang on to others way too long. But if you focus on stocks like these, you improve your odds. The best of the bunch will more than overcome your losses and leave you with highly satisfactory long-term returns.

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Utilities and Canadian Finance are some of the best blue chip companies with high dividends

We continue to recommend that you spread your investments out across most if not all of the five main economic sectors. The proportion of your holdings you devote to each sector depends on your temperament and financial goals.

For example, if you’re an income investor, you may wish to place more emphasis on Utilities and Canadian banks. That’s because these firms generally pay high, secure dividends, and have long histories of raising their payments, even during downturns. However, you’ll still want to make sure your portfolio is well-diversified across most if not all of the sectors.

By diversifying across most if not all of the five sectors, you avoid overloading yourself with stocks that are about to slump simply because of industry conditions or investor fashion.

Blue chip companies with high dividends should be your main target—and Canadian dividend stocks offer an added bonus

A company with a long-term record of paying dividends is generally one that is most deserving of the “blue chip” label in its traditional sense. Dividends, after all, are much more stable than earnings projections. More importantly, dividends are impossible to fake—either the company has the cash to pay them or it doesn’t.

That’s not to say there won’t be surprises that affect every company in a particular industry. But regardless of whether investors opt for stocks with a high dividend yield, picking well-established, dividend-paying stocks benefits most investors. They have the asset size and financial clout (including solid balance sheets and strong cash flow) to weather market downturns or changing industry conditions.

Dividend stocks that meet our Successful Investor criteria offer both capital-gains growth potential and regular income. In fact, dividends are still likely to be paid regardless of how quickly the price of the underlying stock rises.

What’s more, dividends from Canadian companies may come with a tax credit. This cuts your effective tax rate.

All in all, it’s realistic to assume dividends from blue chip companies will continue to contribute around a third of your total return.

Watch out for blue chip companies with unsustainably high yields

When looking for blue chip companies with high dividends, you should avoid the temptation of seeking out stocks with the highest yields simply because they have above-average yields.

That’s because a high yield may signal danger rather than a bargain if it reflects widespread investor skepticism that a company can keep paying its current dividend.

Dividend cuts will always undermine investor confidence and can quickly push down a company’s stock price.

Above all, for a true measure of stability, focus on stocks that have a high-yield dividend that has been maintained or raised during economic or stock-market downturns. Generally, these firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they also provide an attractive mix of safety, income and growth.

To reiterate: a high dividend yield may be a danger sign. It may mean insiders are selling and pushing the price down. A falling share price makes a stock’s yield go up (because you still use the latest dividend payment as the numerator to calculate yield—but the denominator, the price, has dropped).  However, when a stock does cut or halt its dividend, its yield collapses.

A classic case is the now defunct Yellow Pages Income Fund. When it first issued units in 2003, it was widely trumpeted by brokers and in the media as a well-established company.

Yellow Pages stayed in the limelight even though its high dividend yield—consistently above 10%—was a big warning sign. We never recommended the shares, advising investors to stay away from them. In August 2011, the company’s credit rating was downgraded to junk status; in September 2011, it cut its dividend altogether. By then the yield was above 30%.

A track record of dividend payments is a strong sign of reliability and an indication that investing in the stock will be profitable for you in the future—but look carefully at all aspects of the stock. 

Use our three-part Successful Investor approach to find blue chip companies with high dividends 

• Hold mostly high-quality, dividend-paying stocks.
• Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
• Downplay or stay out of stocks in the broker/media limelight.

Does a blue chip yield impact the way you think about a stock’s price?  

How much does dividend yield influence your decision to invest in any particular stock?