These Dividend Stocks Won't Let You Down

It used to be that if you were a risk-averse investor, you could count on blue-chip dividend stocks to hold their own no matter what the market was doing. Lately, though, no company has been completely safe from the impact of the recession, and shareholders in hundreds of companies have suffered from dividend cuts that have ravaged their portfolios.

Yet figuring out how to stay away from stocks that will cut their dividends is a tough assignment. Even companies like Dow Chemical (NYSE: DOW) and General Electric (NYSE: GE), which had paid steadily increasing dividends for decades, had to cut them drastically earlier this year.

How to get some protection
Given the recent turmoil, you might feel like dividend stocks just aren't worth the risk right now. But despite how many companies have fallen prey to dividend cuts lately, there are ways to predict whether your stock is likely to cut its dividend anytime soon. Here are four:

• Strong profits. If a company doesn't earn much more in profits than it pays in dividends, then it's especially vulnerable if its financial results go bad for a year or two. On the other hand, companies that earn a lot more than they pay in dividends can handle temporary setbacks without putting their shareholders at risk -- and also have extra cash available to reinvest in their businesses or buy out other promising companies. So you want to find companies with a low dividend payout-to-earnings ratio.
• Smart dividend yields. With dividends, it is possible to get too much of a good thing. Obviously, the higher the yield, the more income you'll get from owning the stock. But when yields get too high, it becomes clear that they're not sustainable, and eventually it'll cost you when the inevitable cut comes.
• Long histories of higher payouts. As GE's recent experience shows, just because a company has a long history of increasing dividends doesn't mean it won't cut payouts when times get tough. But in general, a company that strives to build a track record of higher dividends wants to avoid ruining that record at all costs. It's far easier, on the other hand, to cut a dividend if you haven't been paying one for decades.
• Good value. When stocks get too expensive, it's easy for the business to get ahead of itself. That, in turn, can lead company managers to pay dividends that prove to be overly ambitious.

If you want to look for the safest dividend stocks, you'll want to find ones that meet all four of those criteria. The exact combination of parameters you look for will clearly change which results you get. But to give you a sense of what sort of stocks you'll find, I looked for companies with payout ratios of 50% or less, dividend yields ranging from 3% to 5%, P/E ratios of 15 or lower, and at least five years of consecutive dividend increases. Here are some of the companies I came up with:

Source: Yahoo! Finance, DividendInvestor.com.

Now before you go out and buy all those stocks, keep in mind that whether a company can sustain its dividend is just one factor that smart investors use to pick good income stocks. At our Motley Fool Income Investor newsletter, lead advisor James Early and his team of specialists look for a combination of attractive features in stocks, including:

• Strong potential for capital gains.
• Great management.
• Financially solid balance sheets that can withstand tough markets.
• A competitive advantage in their industries.

In other words, it's not enough that the company pays a good dividend. It also has to have a strong underlying business model that will continue to work for years.

Keep those dividends coming!
Dividend-paying stocks have a history of producing outsized returns for investors. But it's essential to do your best to stay away from stocks that are going to reduce their dividends. In such situations, you lose twice: You not only suffer the direct loss of income from the dividend reduction, but you also typically see share prices plummet as concerns about the health of the company arise.

That's why the Income Investor team works so hard to look for warning signs that a company may cut its dividend in the future. By staying on top of their stock recommendations, they not only seek out dividend payers with large return potential, but also they avoid possible landmines and keep your money safe.

If you'd like to see which stocks they're recommending now, consider taking advantage of a free 30-day trial. You'll see all their current and past stock picks along with the analysis behind them. Just click here to get started today.

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Fool contributor Dan Caplinger looks for dividends anywhere he can find them. He still owns shares of General Electric, unfortunately. Johnson & Johnson and Procter & Gamble are Income Investor picks. The Fool owns shares of Procter & Gamble. The Fool's disclosure policy never lets you down.