Building a Portfolio of the Best Dividend Paying Stocks: Where to Find Them and How Many to Own

Where do you find the best dividend paying stocks you ask? It's time to put your hard hat on because we are about to find out where to find these companies and how to build a diversified portfolio of them!

Before we discuss where to find them, let's first run through their characteristics. We generally look for companies that...

a) Sell products that are necessities to life and are purchased over and over again to create reoccurring sales. Things like shampoo and tooth paste for example are needed regardless of whether the economy good or bad and are purchased again when they run out!

b) Sell well known branded products across the globe. People tend to stick with their preferred brands so this gives the best dividend paying stocks the ability to increase prices. Global sales are a form of diversification because while one economy may be sluggish, another may be growing rapidly (eg Emerging markets).

c) Have a history of doubling earnings every 5 to 7 years. This is important for dividend growth!

d) Meet our selection criteria. They should have strong balance sheets, quality management, competitive advantages and long histories of paying out and increasing dividends for their shareholders. Click here for our criteria for selecting dividend paying stocks.

A good place to look to for a list of the top dividend stocks is the dividend achievers index. This index lists companies that have increased their dividends every year for at least 25 years... a thing of beauty!

So which industries should you look to for the best high paying dividend stocks? See below for the top industries...

Consumer Staples

These companies are excellent places to look for the best dividend paying stocks. Consumer staples are widely considered to be “defensive” in nature. This is because they sell products that are needed regardless of whether the economy is up or down.

Consumer products companies, food and beverage companies, and tobacco companies all belong to this sector.

You will find companies in this space that sell well known brands all over the world. This is a great place to look for high yield and dividend growth.

Banks

The banking sector is vital to the health of the economy. Banks take in deposits and lend out that money to others for interest.

The downside to this industry is that it’s a commodity business, meaning everyone sells the same product. In a commodity business, the low cost producer wins the race. So a good strategy is to look for a bank that can access capital at the lowest cost relative to its peers.

Although banking is a commodity business, customers generally stay with the same bank as long as they are being serviced well. So a bank’s relationship with its customers is another very important thing to evaluate.

Banking stocks can also offer a very good combination of high current yield and dividend growth. This makes for a powerful wealth creator!

Utilities

It would be hard to find products that are more necessary for day to day living than utilities! Even if the economy is in the worst of times, people will still need to heat their homes, keep the lights on, shower and cook food.

There is also a very high barrier to entry to this industry. It would be extremely expensive for a new company to build the necessary infrastructure required to supply these services to a community.... not to mention the political approvals!

Utilities are generally regulated by the government so growth may not be as fast as some of the industries mentioned above. However, earnings are very predictable and reoccurring so this fits the mold of the best dividend paying stocks.

You will find a decent combination of high current yield and dividend growth here as well.

Services

This sector is made up of many types of companies in many different industries. Waste management companies, payroll companies, food distribution businesses... the list is long!

Service companies often have contracts in place which makes for very predictable and reoccurring revenue. Very attractive for us as dividend investors.

This is another great place to look for the best dividend paying stocks.

REITs (Real Estate Investment Trusts)

These are investment companies that purchase and manage various types of incoming producing real estate such as office buildings, shopping malls, apartment buildings etc. Their shares can be purchased on the major stock exchanges.

REITS offer a very predictable and growing revenue stream from a solid asset base.

Our selection criterion for REITs varies slightly from other stocks because of the nature of the business. For starters, the usual financial ratios such earnings per share and price to earnings ratio don’t really apply.

The FFO (Funds From Operations) ratio is used to accurately represent a REIT’s earnings. You can find this ratio in their financial statements.

To calculate the dividend payout ratio (or FFO payout ratio) divide the dividends per share by the FFO per share.

We look for an FFO payout ratio under 70%, a debt to capital ratio under 50% and a solid asset base (AAA rated companies as tenants locked into long term leases). They should also have a solid management team in place with a significant ownership stake in the company.

If chosen correctly REITs can provide high current yield and dividend growth as part of your compounding portfolio!

Diversification

The above industries offer stable and reoccurring revenue... your best friend as a dividend growth investor!

We tend to avoid cyclical businesses that continuously go through boom and bust periods such as energy and consumer discretionary because their earnings are not predictable.

Our diversification strategy is to own 20 of the best high paying dividend stocks from the above sectors so that no more than 5% of the total portfolio is invested in any one company. You should also aim to diversify by industry and geography.

It's ok if you own fewer than 20 stocks when you are starting out as it's important to watch your transaction costs. You will be able to slowly add new positions as you go.

When you invest in more than 20 stocks, it becomes very difficult to manage the performance of each holding. You should know each of your companies very well. Will you have the time to read through more than 20 quarterly earnings reports?!

So there you have it my fellow dividend investor... a strategy for building a portfolio of the best dividend paying stocks. Well done!

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