Learn how to find top high dividend investments by understanding what to watch for—both pros and cons

One of the best ways of picking quality high dividend investments 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.

When you’re looking for income-producing stocks, dividend yield is typically your most important consideration—but not always. More on that below.

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While a high dividend yield is often a sign of a good investment, it can also entail a lot of risk

The dividend yield is one of the important ratios to calculate for dividend stocks. It is calculated as the total annual dividends paid per share, divided by the current stock price. Movements in the stock price will change the dividend yield.

However, 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). But 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 (although we viewed it as the over-the-hill division of a formerly well-established company).

The company stayed in the limelight even though its high dividend yield—consistently above 10%—was a big warning sign. We never recommended the shares of Yellow Pages Income fund, 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%. The company has since restructured to cut its massive debt and re-emerged as Yellow Pages Ltd.—but the original shareholders of Yellow Pages Income Fund got nothing in the reorganization.

Putting the best high dividend investments in your diversified portfolio is one of the most profitable things you can do

It’s realistic to assume dividends from blue chip companies will continue to contribute around a third of your total return. In addition:

Dividends can grow. Stock prices rise and fall. Interest on bonds holds steady at best. But dividend paying stocks like to ratchet their dividends upward—hold them steady in a bad year, raise them in a good one. That gives you a hedge against inflation.

Dividends are a sign of investment quality. Some good companies reinvest profit instead of paying dividends. But fraudulent and failing companies are hardly ever dividend paying stocks. So if you only buy stocks that pay dividends, you’ll automatically stay out of almost all the market’s worst stocks.

For a true measure of stability, focus on those companies that have maintained or raised their dividends during the recent recession and stock-market downturn. That’s because 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 provide an attractive mix of safety, income and growth.

The best companies to invest in for a high dividend yield also have strong positions in healthy industries. They also incorporate strong management that makes the right moves to remain competitive in changing marketplaces.

Here’s what to do to find the best stocks paying the highest dividends—and how to determine if they will keep paying them

• Look for companies with a history of long-term success.
• Examine the current financial health of the company.
• If a company currently offers a steady dividend, this is a good sign of its potential to continue doing so.
• Look for companies with a strong hold on a growing market and a unique product or service that cuts its competition.
• Download our free report Dividend Paying Stocks: How High Dividend Stocks Can Supercharge Your Income Investing to build strength into your portfolio by investing in the best high-quality dividend stocks.
• Subscribe to TSI Network’s Dividend Advisor. When a dividend-paying stock grabs our attention, we write about it here.

Use our three-part Successful Investor approach to find the best high dividend investments

1. Invest mainly in well-established, mostly dividend-paying companies; they have the experience and strength to survive and prosper despite setbacks.
2. Spread your money out across most if not all of the five main economic sectors; in any setback, some sectors do much better than others.
3. Downplay or avoid stocks in the broker/media limelight; that’s where failed predictions can do the most damage to your finances.

Have you ever bought a high dividend investment only to sell it before the stock fell?

What is your experience with buying stocks with steady dividends? How have they contributed to your portfolio?