How to Invest in Top Dividend Paying Stocks

Some investors feel that the top dividend paying stocks are those companies that offer yields in the double digits. While there are plenty of income trusts and speculative stocks that offer double digit dividend yields, investors are probably better off looking elsewhere. Any stock that offers a yield above 6% or 7% is either setup as a company that pays most earnings in the form of dividends, or will be making a dividend cut very soon.

Instead of chasing risky high yielding stocks, investors can find more stability in top dividend paying stocks from traditional blue chip companies. These are the companies that have been increasing their dividends for consistently for many years and have the earnings outlook to continually increase payouts each year.

The first place to start your search for the top dividend paying stocks is the Standard and Poor’s list of dividend aristocrats. Members of this index include some of the most well regarded dividend investment options available. Blue chip companies like Procter & Gamble (PG), Johnson & Johnson (JNJ), and Wal-Mart (WMT) are just a few of the many great stocks found on the index.

Not just any stock can become an aristocrat. In order to be part of the index, a stock must first be a member of the S&P 500 which ensures the company is a decent size organization. The second (and more important) criteria for inclusion into the index is that the company must have raised dividends annually for at least the past 25 years.

While every stock found on the list of dividend aristocrats may not make a great investment, it provides are starting place for investors to find possible ideas. Each year the dividend aristocrat’s index is reviewed and any company that has either maintained their distributions or made a cut is dropped from the list. At the same time, companies that now meet the criteria to become a member are added. This ensures the index is reviewed and cleaned up each year.

Believe it or not but the top dividend paying stocks don’t have the highest yields. Companies that have double digit yields make for very risky investments that should be avoided if possible. Instead, look for companies with a dividend yield between 2.5% and 6%. If the yield is lower than 2.5%, then you can probably find a CD or savings account that could guarantee your investment at a close rate. A company with a yield higher than 6% should also raise a red flag as yields higher than this range are often hard to maintain.

Another important characteristic of top dividend stocks is the payout ratio. How much is the company using of their earnings to pay the dividend. If the company raises their dividend every year it is considered a good sign. However, the payout ratio will identify if the company is using more and more of their earnings to raise the dividend. Investors should look for a company that raises distributions every year but also continues to grow the company and not pass all earnings on to shareholders as dividends.

Is your stock under or overvalued in the marketplace? One way to tell is by looking at the price-to-earnings ratio. For top dividend paying stocks, it is good to look for companies with a trailing P/E of 20 or below. Anything higher and you are probably overpaying for the stock. The lower the P/E, the better deal you are getting on the investment. It can also be a good idea to check out the forward P/E to see how earnings estimates for the next year compare to the current share price.

In order to invest in the top dividend paying stocks, it is critical for investors not to chase high yields. While there may be some good investments with dividend yields above 7%, there are more risky ones to watch out for. The key to building a long lasting dividend portfolio is to look for solid blue chip companies instead. Factoring the current yield, payout ratio, and price-to-earnings numbers can help investors narrow down their search. Using a published index of stocks, such as the dividend aristocrats index can also help you find the best investment options to build your portfolio.