Knowing not only what investments pay dividends—but also which payouts are sustainable—will help you determine the best places to put your investment dollars

Companies pay dividends to attract shareholders and reward them for owning stock in the corporation. It’s a long-established practice. Joint-stock companies were formed in Europe as early as the 1200s. The first to pay a dividend was the Dutch East India Company in the early 1600s. Not coincidentally, it also began trading its shares on the Amsterdam Stock Exchange, making it easier to attract more investors.

Not all dividend stocks are equal. Some dividend-paying stocks will provide more value for investors over the course of time. Understanding what investments pay dividends that are sustainable can lead to bigger gains.

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Invest in dividend stocks for portfolio gains

Dividends are far more reliable than capital gains. A stock that pays a $1 dividend this year will probably do the same next year. In addition, top dividend-paying stocks like to ratchet those payments upward—hold them steady in a bad year, and raise them in a good one. That also gives you a hedge against inflation.

For a true measure of stability, we focus on those companies that have maintained or raised their dividends during economic downturns. 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.

Look at a company’s dividend payout ratio for help in determining what investments pay dividends that are truly sustainable

One of the best ways to judge whether a company will keep paying its dividend, or even increase it, is the dividend payout ratio. This simply measures what portion of a company’s earnings are allotted to paying dividends.

If a company keeps its payout ratio fairly steady, say at 7% of earnings, and its earnings grow, the amount you receive in dividends should also grow. However, if a company must keep paying out a larger and larger percentage of its earnings just to maintain the dividend, it is reasonable to wonder whether the company is in decline and the dividend is in danger of being cut.

You need to look at other factors, as well, of course. The company may be going through a low cycle in its industry, or have a temporary problem it has a good chance of solving.

Look at industry-dominant companies for examples of what investments pay dividends and at the same time are worth your investment dollars

We look for dividend stocks that have industry prominence, if not dominance. Our reasoning, besides brand recognition, is that major companies can influence legislation, industry trends, etc. to suit themselves. Minor firms can’t do that.

Dividend stocks are an important contributor to your long-term gains, and dividend-paying stocks tend to expose you to less risk than non-dividend-payers. That’s why the majority of your stocks should be dividend-payers at all times. As you get older and closer to retirement, you should raise the proportion of dividend-paying stocks in your portfolio, to cut risk and improve the stability of your investment results.

Find out what investments pay dividends consistently and consider those for you portfolio

One of the best ways of picking a quality Canadian 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 commonality that all the best dividend stocks have.

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

Always use our three-part Successful Investor approach while investing in stocks that pay monthly dividends, and you can profit more over the long term

First, invest mainly in well-established companies. When the market goes into a lengthy downturn, these stocks generally keep paying their dividends, and they are typically among the first to recover when conditions improve.

Second, spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities). This helps you avoid excess exposure to any one segment of the market that is headed for trouble. This will also dampen your portfolio’s volatility in the long term.

Third, avoid or downplay stocks in the broker/media limelight. That limelight tends to raise investor expectations to excessive levels. When companies fail to live up to expectations, these stocks can plunge.

An extremely high dividend yield can be misleading. How do you ensure you are investing in the most reliable stocks?

Have you invested in a dividend-paying stock that later stopped paying dividends? What happened?