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How to Find the Best Dividend Stocks

By Rick Munarriz – Aug 29, 2020 at 3:00PM

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Chasing yields can be lucrative but also dangerous if you don't know how to excel as an income investor.

Investors are flocking to dividend-paying stocks, and it's not as if you can blame them. Conservative investors that have lived off a steady diet of money market funds, CDs, and T-bills are looking for more than the sub-1% yields they're getting from their fixed income vehicles. Here's where stocks with regular quarterly disbursements come in.

Quality companies paying quality distributions are great, but finding them isn't easy. Let's go over some of the things to watch for -- and to watch out for -- on the quest to find the best dividend stocks. 

A jar of coins sealed by a rubber band, labeled as dividends.

Image source: Getty Images.

The higher the yield, the higher your skepticism should be

Every high-yielding stock has a story to tell, and it's usually not one with a happy ending. There isn't some magical screener that nobody knows about to filter undiscovered investments with sky-high yields. If there's a stock with a fat payout, there's probably a good reason why folks have let the stock trade so low that its yield is so high.

There are more than 500 stateside-listed investments currently commanding yields north of 7%. If I can offer two words of advice: run away. Most of these vehicles are limited partnerships, closed-end funds, and REITs with fading prospects. There are a few stocks that are household names here.

You know ExxonMobil (XOM -1.01%), the crude oil and natural gas giant that at one point just seven years ago commanded the country's largest market cap? It's a different world now. With crude oil and natural gas prices plummeting even before the pandemic weakened demand, it's not an easy place for investors to be. The 8.8% yield is going to seem awfully tempting, but how does that offset the stock's 39% year-to-date drop? The latest insult is that it's getting booted from the Dow.

Altria (MO -0.40%) is another blue chip. It's the tobacco giant behind Marlboro cigarettes, JUUL vaporizers, and several other products with dubious health prospects. The 7.9% yield is tempting, but like ExxonMobil this is another stock checking in with a double-digit percentage slide in the shares this year to more than offset the distributions. 

Buy stocks first and yields later

Hopefully I've talked you off the ledge of fat dividends. Even if income is your goal, always approach a potential investment from the perspective of capital appreciation. You don't want to be tricked into buying bad stocks in bad industries because they happen to be dangling even modest-sized yields. 

Earlier this year shares of cruise lines, airlines, multiplex exhibitors, and amusement park operators had meaty yields that became even beefier when their stocks started to tumble as the pandemic gained steam. Nearly all of them went on to suspend their dividends. 

Payouts are only as sustainable as the company's ability to keep paying them. Apple (AAPL -3.67%) -- the tech bellwether that ExxonMobil overtook in early 2013 for the market cap crown -- only commands a 0.6% yield, but that includes yet another springtime hike earlier this year. The stock has soared 70% this year as the market embraces its unique premium position in consumer electronics and its faster-growing services. The oil and gas giant was briefly the more valuable of the two stocks seven years ago, but Apple now commands a market cap that is 12 times greater than ExxonMobil.

A stock with a yield below 1% may seem inferior to ones like ExxonMobile and Altria at nearly 8% or higher, but history tells you that the best dividend stock is rarely the one with the highest yield. If you want to learn how to invest in dividend stocks, always keep in mind that a yield is never as important as the underlying stock. 

Rick Munarriz owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Apple Inc. Stock Quote
Apple Inc.
AAPL
$140.09 (-3.67%) $-5.34
Exxon Mobil Corporation Stock Quote
Exxon Mobil Corporation
XOM
$101.03 (-1.01%) $-1.03
Altria Group, Inc. Stock Quote
Altria Group, Inc.
MO
$42.82 (-0.40%) $0.17

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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