Not all of the top paying dividend stocks are worth buying because some dividends are unsustainable

Top paying dividend stocks are a valuable component of any sound investing portfolio. All in all, we think that dividends can contribute up to, say, a third of your long-term investment returns, even without the tax-cutting effects of the dividend tax credit.

However, not all dividend-paying stocks are worth investing in and sometimes unusually high dividend yields are a sign of danger. Read on to discover when to avoid high-yielding dividend stocks.

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Top paying dividend stocks have a history of paying a dividend

One of the best ways of picking a quality dividend stock is to look for companies that have been paying dividends for at least 5 to 10 years. Companies can trump up quarterly earnings, issue press releases to appear to be making strong progress, but they cannot fake dividends. Dividends are cash outlays that an unsuccessful company could never produce. A history of dividend payments is one thing that all the best dividend stocks have in common.

Top paying dividend stocks are truly high-quality investments

We recommend that you buy high-quality stocks. These stocks have generally been succeeding in business for a decade or more, perhaps much longer. But in any case, they have shown that they have a durable business concept. They can suffer in economic and stock-market downturns, like any stock. But most thrive again when the good times return, as they inevitably do.

Watch out for stocks with an unusually high dividend yield

Investors should avoid judging a company based solely on its dividend yield (the percentage you get when you divide a company’s current yearly payment by its share price). That’s because a high yield can sometimes be a danger sign rather than a bargain. For example, a dividend paying stock’s yield could be high simply because its share price has dropped sharply (because you use a company’s share price to calculate yield) in anticipation of a dividend cut. That’s why we recommend that you look beyond dividend yield when making investment decisions, and look for companies that also have established a sound business and have a history of building revenue and cash flow.

In some cases, a high dividend yield can also be misleading.

The dividend yield is the percentage you get when you divide the current yearly dividend payment by the share or unit price of the investment. It’s an indicator we pay especially close attention to when we select stocks to recommend in our investment newsletters.

But an attractive yield, and especially a very high dividend yield, can give you a false sense of security. That’s because some investors have a tendency to think that all investment income is almost as safe and predictable as bank interest.

The fact is that investment income can dry up suddenly. Money-losing companies are sometimes unable to keep paying a long-standing dividend, and they sometimes spring the bad news on their shareholders with little or no warning.

Can you eliminate losing stocks to make way for top paying dividend stocks?

If you look back at the history of the most successful stocks on the market, you’ll find many have dropped 30%, 60%, even 90%, at one time or another, in past market declines. They then went on to recover.

Many investors try various ways of eliminating losing stocks from their portfolios. These efforts often backfire. Some lead you to sell stocks that had already fallen a great deal, and are ripe for a rebound. Others lead you to switch into better-performing groups, just when these groups may be on the verge of joining in the plunge. Worst of all, some may lead you to give up on the market altogether and “go into cash,” just when the entire market is close to a bottom.

The best way to minimize losers is to understand the underlying message of our three rules, and apply them more diligently. Be very careful about the quality of stocks you buy. Diversify and balance your holdings. Avoid fads.

When you want the top paying dividend stocks in your portfolio, where do you turn towards first to find them? Please share your thoughts with us in the comments.