Dividend stocks: How to find the best ones

For do-it-yourself investors, it takes time to research and analyze stocks to determine the best fit for your portfolio.

I like to invest in stocks which have a consistent record of increasing their dividends over time.  Here are four factors that I consider when selecting a dividend stock for my portfolio. 

Low Price / Earnings Ratio

The price-to-earnings ratio is calculated by dividing the stock’s current price by its earnings per share over the past 12 months.  A low P/E ratio may be a sign that the company had a difficult time meeting earnings expectations from the previous year.  But if the company has an otherwise solid history of earnings and growth, a low P/E ratio can be a good indicator of value.

P/E ratios vary from industry-to-industry so if you are using P/E ratio as part of your investment selection criteria, make sure to compare companies in the same industry.  Utility stocks that are more mature and stable with lower growth potential may have lower P/E ratios than stocks from the faster growing technology sector.

High Dividend Yield

Dividend yield is determined by dividing the annual dividend per share  by share price.  This  simply looks for stocks with the highest yield.

When identifying high dividend yield stocks it’s important to consider whether the dividend is at risk.  A high dividend payout ratio, especially compared to the typical industry standard, could indicate that a dividend reduction is imminent.

Related: How to spot a dependable dividend yield

5-year dividend growth average

A dividend aristocrat typically increases dividends for a number of consecutive years.  Some strict dividend growth stock investors use 25 years of consecutive dividend increases as their benchmark, and others may go as low as 5 consecutive years.

Due to the recent global financial crisis many dividend aristocrats put their dividend increases on hold in order to strengthen their balance sheets.  The 5-year dividend growth average is a good measurement to see how committed a company is to growing their dividends.

5-year average dividend yield

The final criteria that I use for selecting a dividend stock is to look at the current dividend yield and compare it to the 5-year average dividend yield.  If the current dividend yield is higher than the 5-year average, this can indicate that the stock is under-priced.

I ran through these screens and found four dividend paying stocks that meet my criteria:

*As of February 15, 2012

Keep in mind that any broad stock screening process is just a starting point and should be followed up with more detailed analysis of the company before investing.

Also Read:

How to find safety in the market storm

Two investments for nervous people

Robb Engen is half of the Boomer & Echo personal finance blogging team with his mother, a former financial advisor.  Reach him at robbengen@gmail.com