Finding the Perfect Dividend Stock

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"Do you know the only thing that gives me pleasure? It's to see my dividends coming in."

-- John D. Rockefeller

In one of my previous jobs, I helped manage a group of large individual investment portfolios. Some, in fact, were nine-figures kind of large.

The biggest investing lesson I took from studying those successful portfolios was: Buy dividend-paying stocks and, most importantly, buy them early.

See, these portfolios contained long-term winners like Procter & Gamble (NYSE: PG), which, in most cases, had been bought decades earlier and were now paying out tens of thousands of dollars in annual dividend income.

The owners of the portfolios didn't just pick stocks like P&G out of a hat of blue chips and hope for the best. No, they took the time to select companies with sustainable business models with a long track record of increasing shareholder value through capital gains and dividend growth.

That extra effort to handpick the perfect dividend stocks certainly paid off for them, to say the least, and they're reminded of their wise decision each quarter when their dividend checks roll in.

Your turn to build a dividend dynasty
Not all dividend stocks are created equal, however. Witness the recently slashed dividends from financial stocks like National City (NYSE: NCC) and CIT Group (NYSE: CIT), which serve as a harsh reminder that dividend payments are not guaranteed. That's why it pays to study the company's free cash flow and payout ratio to make sure it can continue to pay dividends.

Before we get into all of that, however, let's get you a few dividend stocks to research. To get you started, we'll employ the help of both the 99,000 investors participating in Motley Fool CAPS and the new CAPS stock screener, which we will use to find dividend-paying stocks with:

• Return on equity greater than 10%.
• A dividend yield greater than 3%.
• A four- or five-star CAPS rating.

Here are a few of the results:

Company	CAPS Rating (out of 5)	Dividend Yield
Taiwan Semiconductor (NYSE: TSM)	*****	3.4%
British American Tobacco	****	4.8%
DuPont (NYSE: DD)	*****	3.3%
Dow Chemical (NYSE: DOW)	****	4.3%
Rayonier REIT (NYSE: RYN)	*****	4.6%

Data from Motley Fool CAPS and Yahoo! Finance as of 4/24/08.

These stocks appear to be promising, but this is not a list of formal recommendations. Instead, use it as a starting point for further research.

Harvesting cash
Florida-based Rayonier operates in the obscure timber real estate investment trust (REIT) category that also includes Plum Creek Timber and Potlatch.

Like other REITs, those in timber, like Rayonier, are generally required to pay at least 90% of their taxable income to shareholders. But there's a bit of a difference that's worth noting. Unlike other REITs, those investing in timber derive most of their income from the harvest of timberlands, which are treated as a long-term capital gain and not regular income.

One benefit of this format is that timber REITs' dividend payouts are generally treated as long-term capital gains -- currently taxed at a cap of 15%. By contrast, dividend payouts from other REITs, like those in the commercial and residential real estate business, are taxed at the individual's regular income tax rate.

Timber REITs have another advantage, in that they sell a renewable resource. For example, if rent rates plummet on a commercial property, that's irreplaceable income for a commercial REIT, and by extension its shareholders. Timber REITs, on the other hand, can react to a slow economy by reducing their harvesting rate and increasing tree planting, so when the economy picks up again, they will have plenty of timber to meet demand.

In this era of low interest rates, Rayonier's juicy yield of 4.6% is all the more appealing; what's more, it has posted an average yield of 4% over the past five years. CAPS investors think the good times will continue: 97% of the players who have rated the stock think it will outperform the S&P 500. One of these timber bulls is CAPS player JamieWinsBig, who argued in November that Rayonier has a lot going for it:

Rayonier is in the timber and land business, that has consistently made very smart purchasing and selling decisions. Timber is on the way back up and Rayonier will benefit for years to come ... And with a yield of almost 5%, what's not to love? Listen to their last company meeting, these guys have it going on.

So far at least, JamieWinsBig's advice has been justified -- Rayonier has outperformed the S&P by four percentage points since that CAPS recommendation. Shares don't appear cheap at the moment, however, with shares sporting a PEG ratio well over 3, so investors would be wise to do more digging before making an investment.

What do you think? Will Rayonier prove the bears wrong and provide dividend riches for patient investors, or will it be chopped down to size? CAPS' 99,000 investors are waiting to hear what you think. So sign up today. CAPS is 100% free and guaranteed to educate, amuse, and enrich.