The Best Dividend Stocks - The Dividend Aristocrats

As a tool for creating steady passive income, the dividend has stood the test of time. Studies show that from 1926 to 2004, dividends accounted for 35% of shareholder returns. However, after adding in the powerful effects of reinvesting the dividends and compounding, dividends returned over 25 times more than price appreciation.

During the tech bubble/dot.com boom of the late 90's, many investors ignored dividend paying stocks when looking for the best stocks to buy. However, that's no longer the case, as now, even many tech companies have begun paying dividends.

In fact, since 2003, CNN reports that "there were over 100 dividend increases and initiations among tech firms, vs. 4 dividend cuts. Initiating dividend payouts helped these companies to win back investor confidence soon after the Internet bubble burst."

So what makes this group of dividend stocks so special? After all, not every dividend stock is worth buying, even if it pays a very high dividend. As a matter of fact, an abnormally high dividend yield can often be a warning signal to income investors to avoid a stock, even though it may have the highest dividend in its peer group.

What distinguishes the S&P's Dividend Aristocrats group is that these are stocks which have increased their dividends for the past 25 consecutive years. Remarkably, some of these companies have increased their payouts for over 50 years running. These are stocks with a long, steady history of dividend growth, to say the least.

Logic would also suggest that any company that can make these consistent increases, must have a strong business model, with ample cash flow to support their payouts through both good and bad economic cycles. However, since the current economic downturn of 2008-2009, some of these firms have actually cut their dividends, and will be eliminated from the group next year.

So, which companies in this group are actually the best stocks to invest in? Should you just buy stocks with the highest dividend yield, or is there a better way to find the best dividend stock to invest in?

First of all, take a look at the industry sectors: Are there attractive stocks in a beaten-down or currently lagging sector, such as health care, or utilities? For example, these 2 sectors are only up 6.5% and 7.1%, respectively, in 2009, whereas the basic materials sector is currently up over 27%!

As a value investor, you may want to seek out stocks who haven't made huge dramatic runs up to new highs, but, rather, have been somewhat left behind. The trick to this strategy is making sure that the stock or its peer group doesn't have serious internal problems, or external problems. For example, tobacco companies were solid stocks to invest in for many years, until their related health problems emerged.

Always compare a firm to its peers to get a clearer picture of its strengths and weaknesses. A good place to do this is the clearstation website, which has a pulldown menu with a feature called "key ratios", with which you can compare a stock to its industry, sector, and the S&P simultaneously. You'll see comparisons of many metrics, including: market cap, sales per employee, dividend yield, dividend growth rate, return on assets, return on equity, return on investment, p/e, price to book, price to cash flow, debt to equity, and many other metrics.