4 Steps to Premium Dividends

Fact: Dividend-paying companies outperform nonpayers over time. And for you nonbelievers, there are stats to prove it. Unfortunately, it's not easy being a dividend investor. The search for high yields can lead to complicated industries such as banking, real estate, utilities, and -- gasp -- telecom.

Believe me, it's a jungle out there. Lurking in the shadows of such industries are strange and scary creatures. Look out for the net interest margin! Beware of adjusted funds from operations (AFFO)! In this unfamiliar world, gross margins and inventory turnover are nowhere to be found.

Fortunately, we're here to help. You're going to need a plan if you want to find the best dividend-paying companies in these industries, and we've outlined four easy steps to get you started.

Step 1: Pick one industry
It's better to know a lot about one industry than to know a little about four. So pick one and know the key metrics and players -- in and out, backwards and forward.

I prefer banking. Maybe it's the vaults full of cash or the stately marble pillars. Or maybe it's the jar of lollipops. Real estate investment trusts (REITs) are also appealing because they provide exposure to high-priced real estate. You'll soon realize it's easier to follow businesses that you find interesting.

Step 2: Make a list
Pick a handful of companies (say, between five and 15) in your industry of interest and map out the key ratios for each. This will give you a framework for evaluating any company in that industry. For residential REITs:

This table provides a sense of ranges across the industry. For instance, the dividend yields for these REITs fall in a range of 2.8% to 4.7%. A residential REIT with a yield of 8%, then, is out of the ordinary -- and may be too good to be true.

Step 3: Forget Yahoo! Finance
Internet portals such as Yahoo! Finance are great for finding surface information about companies with simple business models. A look at margins, inventory, and cash flow on Yahoo! will get you started analyzing retailers like Abercrombie & Fitch (NYSE:ANF) or Best Buy (NYSE:BBY). However, as you search for superior returns in the jungle of high-yield stocks, you're going to need more specific data. Many of the metrics and ratios that the portals provide just don't apply to these industries.

Instead, you need to go straight to the source: the company's SEC filings and earnings announcements.

Step 4: Learn from others
It's easier to survive in the jungle if you've got reinforcements. Learning from other investors will certainly prepare you to venture out on your own.

You can do this by starting or joining an investment club. Or better yet, you can join Fool dividend guru Mathew Emmert at his Motley Fool Income Investor newsletter free for 30 days. Mathew's recommendations have beaten the market by more than four percentage points since 2003 on the backs of steady dividend payers such as GlaxoSmithKline (NYSE:GSK). And with your trial, you'll also enjoy access to discussion boards devoted to helping you understand the ins and outs of market-beating dividend investing.

Foolish bottom line
These four steps will help you navigate the jungle of dividends and get back on track to becoming a better income investor. Along the way, don't be deterred by strange acronyms or creepy accounting entries -- "amortization of deferred financing costs" just sounds foreign, doesn't it? But with a little time and patience, you, too, can be a market-beating, high-yield expert.

Click here for more information about a free 30-day trial to Income Investor. There is no obligation to subscribe.

This article was originally published on Feb. 3, 2006. It has been updated.

Fool financial editor Joseph Khattab does not have a position in any of the companies mentioned. Best Buy is a Stock Advisor pick. The Fool has adisclosure policy.