Hey Dudes, are you interested in investing in dividend paying stocks? Well, if not, you should be! Investing for dividends is a great way to round out your portfolio. Investing in dividend yielding stocks should be a part of everyones investment strategy for two reasons. First, it provides diversification and thus reduces investment risk. Second, investing for dividend yield provides a safe harbor in times of uncertainty or bear markets. But like other investment decisions, you cannot rely on any one ratio or number to pick these stocks.

I have done quite a bit of research related to dividend paying stocks over the past few years and I have discovered some important things to consider when deciding where to put your money. I will summarize these and provide a methodology for evaluating this type of investment.

About Dividends
Most stocks bring you profits only by trading higher over time. Dividend-yielding shares pay you for owning them regardless. Just think: The only way you make money on regular stocks is by selling them to someone else at a higher price. The beauty of dividend stocks is that, because they pay you to own them, you dont have to depend solely on the stocks gains or a strong market to make money. In addition, Stocks with solid dividend prospects dont go down as much as other stocks, because when they start fading, the resulting rise in dividend yield attracts more buyers.

The cash comes to you!
The dividends I am talking about here are the cash dividends that companies pay on a quarterly basis. I am not considering stock dividends sometimes used to implement stock splits or company spin-offs or one-time cash payments. Normally, your broker adds the dividend youve received to your cash account. However, some brokers offer automatic reinvestment plans. With these plans, your dividends are used to purchase additional shares, even if the dividend equates to only a fraction of a share. And many dividend-paying companies offer their own similar plans, called dividend reinvestment plans (DRIPs), for shareholders who buy directly from the company.

Types of dividend stocks
You may automatically think of utilities when talk turns to dividends. But you have lots of other choices. Banks and a variety of manufacturing and service companies also offer them. These stocks can pay dividends equating to a dividend yield as high as 4.5%. Troubled stocks sometimes pay higher dividends. Under the new tax law, the maximum income tax on these dividends will be 15%.

Dividend yield
The estimated dividend payouts over the next 12 months divided by the price you pay for the shares. For instance, if you pay $20 per share for a stock expected to pay $1 per share in dividends over the next 12 months, the yield would be 5%. If youre seeking higher yields, you may find them in real estate investment trusts (REITs), REITs do not pay corporate income taxes as long as they pay out most of their earnings to shareholders. However, their shares trade on the major exchanges just as any other stock. Their dividend yields typically range between 4% and 12%, and in some instances, they run even higher.

About REITs
I myself do not invest in REITs, but I will discuss them briefly. Basically, REITs are required to invest only in real estate. Most REITs own properties like shopping centers, office buildings and residential apartment complexes. The yield is generally liberal since REITs are required to distribute as much as 90% of their income. However, REIT shareholders will not benefit from the new tax law because REIT dividends will still be taxed as ordinary income.

To be successful in dividend investing, you must dig down for stocks with minimal risk of dividend cuts and/or other negative events, and a high probability that the dividends will increase while you own the stock. You win in two ways when the dividend increases. First, the yield on your initial investment goes up with the dividend, and even better, the dividend increase often propels the share price higher. Conversely, a dividend cut shrinks your yield and often precipitates a drop in the share price as well. Here are a few rules about investing in dividend stocks:

Rule #1: Do not only look at the dividend yield.
Investment decisions cannot be based solely, on the basis of which stock has the highest dividend yield. High yields generally mean that the stock price is low (assuming that dividends are fixed), which may be for a very good reason. If the market feels that the company has problems, it will reduce the stocks price and increase the dividend yield. But the yield calculation that appears in the media is based upon current stock price and historical dividends. If the company has fundamental problems (like losing money) that dividend is not safe! Investors must consider more than just yield in order to make good investment decisions. A company that has a history of paying a consistently growing dividend is better than one that pays a consistent, but steady dividend. And the consistent but flat dividend is better than a company who has had to cut its dividend.

Rule #2: Cash flow baby!
Forget net income, EPS does not feed the dividend! Cash pays dividends so you should focus on operating cash flow per share. Here again, consistency is important. A company who generates a steady or growing operating cash flow is better able to fund a dividend than a company that cannot consistently generate cash. A good ratio to look at is the dividend coverage ratio. This ratio is calculated by taking the trailing 12-month operating cashflow per share divided by the last 12-month dividend (or the expected annual dividend). If this ratio is 1.0 or better, there can be a relatively high degree of confidence that the dividend is safe. Below 1.0 indicates that the company must borrow (or sell assets) to pay the dividend because it is not generating enough cash from operations to meet this obligation. This indicates an increased risk that the dividend may not be safe from being reduced or eliminated.

Rule #3: Watch the debt.
Stick with companies with below-average debt -- that is, with leverage ratios below 5.0, and lower is better. (To find the leverage ratio, click on the Financial Results page and type in your symbol. Then go to Key Ratios, and finally select Financial Condition.) This rule does not apply to savings and loans, banks and similar institutions. Borrowed money is their inventory, and most are high-debt by definition. However, the U.S. government carefully monitors all U.S.-based financial institutions, and solvency is not a significant issue.

Rule #4: Stay Informed!
Do not, Buy and forget. Buy and hold is a good strategy for investors, but that does not mean, Buy and forget. You need to monitor the companys performance and news often.

How to find dividend paying stocks.
Dude, there are hundreds of companies that pay dividends, but finding the right one can be tricky. To help you get started, I have composed a list of dividend-paying stocks. It is composed mostly of well-known established companies in the US. It is not intended to be the top, just some examples.

Thanks for reading my article, I hope it helps you understand dividend investing.

Doug