With stocks taking a bath and the prospects for the year getting dimmer, quality is going to trump high returns when it comes to stock picking in 2016. That, in turn, should bode well for dividend paying stocks or ones that pay investors a piece of their earnings. But not all dividend stocks are the same, which is why investors have to first understand the forces driving interest in this area of the market before they can make smart bets. (Read more, here: Introduction To Dividends: Investing In Dividend Stocks.)

Stock Investors Eyeing Quality

Stocks had been enjoying a bull run for some years now as companies successfully climbed out of the great recession and the economy started to mend. Today unemployment is at 4.9%, which is an eight-year low and consumers have increased confidence in their prospects and are thus borrowing and spending again. Even the Federal Reserve stepped in at the end of the year, raising interest rates slightly due to the prospering economy. But 2015 is long gone and since the beginning of the year, stocks have been reeling from concerns over the growth in China and plummeting oil prices that hurt many oil producing companies and the related industries. That, in turn, has prompted a selloff in the stock market so far this year. When stocks are on a downward trajectory, many people look for safe havens. After all, they need ways to cushion the blow and grow their investments, at least, a little bit. As a result, one area that garners a lot of attention is dividend paying stocks. (Read more, here: Investing Basics: Flight To Quality.)

So what do investors get with a dividend paying stock? Often companies that have stable profits and are operating as leaders in their industry. While there is a risk with any stock, the downside is cushioned because of the company’s blue chip qualities. They don’t pay out a huge dividend yield, but they do it on a consistent basis and tend to raise the payout each quarter or year. High-yield stocks, on the other hand, could make you rich because they have a double-digit yield, but the key word is could. In a volatile stock market, the chances are high the company won’t have the money to cover the dividend so you’ll lose out on both the yield and the likely decline in the share price.

Corporations With Cash Can Raise Dividends

Many of the more stable dividend paying stocks are no longer chasing outsized growth but are in a slower growth mode sitting on hordes of cash. And that cash has to be used in some way which is where dividend increases could come in. (Read more, here: How And Why Do Companies Pay Dividends?) Late last year investment firm Goldman Sachs estimated that just over $1 trillion will go to shareholders during 2016, up 7% from year-ago levels. That spending on shareholders is expected to come largely from share buybacks and dividend increases. Companies that are performing well but aren’t chasing a multitude of new initiatives tend to be the ones that have been around for years and aren’t at risk of running out of cash to pay shareholders. Some of the dividend stocks that fall into that category include companies like Ford Motor Corp. (F) and Wells Fargo (WFC). In the case of Ford and other U.S. car companies, they should benefit not only from higher prices on their new cars but a steep decline in gas prices which is freeing up more cash for consumers. As for Wells Fargo, banks tend to benefit in rising interest rate environments.  

Investors Have To Be Choosy  

When it comes to picking dividend stocks in a volatile environment, investors have to be choosy. They also have to be realistic and look at the lower yielding but more stable companies. A stock that pays a dividend yield of 2% to 4% may not be the talk of the country club, but it is going to increase your investment and lower the risk of losing it all. (Read more, here: What’s the Safest Way to Invest in High-yielding Dividend Stocks?) It’s also important to pay attention to the payout ratio of the dividend, which is calculated by taking the dividend and dividing it by earnings per share. It tells investors it the company can afford the dividend amount with its current earnings or if it will run out of cash. If the ratio is over 100%, it means it is paying more than it is bringing in. Investors should stay away from those dividend stocks that have a payout ratio near 100 percent. It’s also a smart bet to go for those companies that have a history of raising their dividend. That’s because companies that regularly raise their dividend are signaling they are healthy and have enough cash.

The Bottom Line

Uncertainty will be front and center in 2016, and that is particularly true of the stock market, which will usher in a flight to quality. One area of quality that is expected to do well is dividend paying stocks. Companies that are paying a good yield with a decent payout ratio tend to do better in times when the stock market is declining. But it’s not all dividend paying issuers that investors stand to profit from. Those higher flying high-yield paying dividend stocks tend to be riskier, particularly in volatile times, which means they can crash harder than their slower growth counterparts. 

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