Know what to look for when buying stock and you will make better buys. This includes top-quality dividend-paying and blue chip shares

Do you know what to look for when buying stock? Our key rule is that you can cut way down on times when you really need to sell by consistently buying well-established, high-quality stocks. Those picks can still drop sharply when the economy falters or bad news strikes, of course. But these are the stocks that snap back most quickly and most reliably when the trend reverses and bad news comes less often. That’s why it generally pays to hold on to stocks like these through market setbacks. But you need to look at each case on its own, since there are exceptions.

Meanwhile, we think that if a stock is truly worth investing in, you should be willing to buy it at current prices, even if that means you run the risk of having to sit through a 5% to 10% setback. Before it puts on its next 5% to 10% setback, after all, it may first go up 50% to 100%.

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What to look for when buying stock: Dividends are a key factor

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 also gives you a hedge against inflation.

Dividends are a sign of investment quality. Some good companies reinvest their profits 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 economic and stock-market 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.

What to look for when buying stock: Blue chip stocks will boost your portfolio

Understand how to research stocks by using financial ratios and advice from successful investors to get strong investment returns

We define a blue-chip company as a well-established company with attractive business prospects. This is always near the top of our list of suggestions of what to look for when buying stock in a company. Well-established stocks have the asset size and the financial clout—including solid balance sheets and strong cash flow—to weather market downturns or changing industry conditions.

Blue chip stocks have strong positions in healthy industries. They also have strong management that will make the right moves to remain competitive in a changing marketplace.

Because of this, blue chip companies can give investors an additional measure of safety in volatile markets. And the best ones offer an attractive combination of moderate p/e’s (the ratio of a stock’s price to its per-share earnings), steady or rising dividend yields (annual dividend divided by the share price) and promising growth prospects.

At the same time, we feel most investors should hold the bulk of their investment portfolios in securities from blue chip companies. All these stocks should offer good “value”—that is, they should trade at reasonable multiples of earnings, cash flow, book value and so on. Ideally, they should also have above average-growth prospects, compared to alternative investments.

What to look for when buying stock: Check for hidden assets

Hidden assets are valuable assets that some investors overlook, discount or disregard altogether. They have special appeal for companies that are using takeovers of other firms to grow. They can be found in real estate and in research and elsewhere.

A hidden asset can come out of existing brand names that can help launch new products. They can also grow out of government obstacles to the entry of new competitors into a market.

If you buy a stock for its hidden assets, those assets may stay hidden or ignored by investors— or turn out to be less valuable than you thought—but it can’t hurt you much. By definition, a stock’s hidden assets have not had much impact on its price so far. If you paid little if anything for the assets, you have little to lose. But the best hidden assets will eventually expand a company’s profits, grab investor attention, and push up its stock price.

Hidden assets should always be looked for while evaluating a stock. Stocks that have them are not rare, but they are hard to find. Once you find a stock with hidden assets, use these three financial measures to evaluate the shares: price-earnings ratios, price-to-book-value ratios, and price-cash flow ratios.

Use our three-part Successful Investor approach for profits when buying stock

1. Invest mainly in well-established, dividend-paying companies;
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; Utilities);
3. Downplay or avoid stocks in the broker/media limelight.

What is the first characteristic of a stock you look for before buying?

Is there a specific quality or feature you look for when determining whether or not to buy a stock?