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Build wealth with dividends

By Judy Martel · Bankrate.com
Tuesday, June 21, 2011
Posted: 4 pm ET

They used to be called widow and orphan stocks. Dividend-paying stocks have earned a reputation as solid, predictable forms of income, but are they still solid?

Dividend stocks offer capital appreciation and income that can be paid to you on a regular schedule or reinvested to boost returns until you're ready for income. This year, many companies, including Oracle and Dow Chemical, began paying higher dividends, making them even more attractive.

But as with any investment, there are risks. Dividend payout policies can change and stock prices fluctuate. As with any income-producing asset, make sure you know the tax implications, and whether it fits with your investment goals.

There are a few things to look at when considering dividend stocks. You want companies that pay dividends, but also reinvest in the company. When it comes to evaluating a company's excess cash flow, keep these two things in mind:

  1. The dividend payout as a percentage of the company's revenue: a higher percentage shows the company is healthy.
  2. Free cash flow: in other words, how much cash per share the company is generating. Once again, that gives you an idea of the financial health of the company.

There are, of course, other ways to generate investment income - including bonds and real estate investment trusts, or REITs, which are required to distribute 90 percent of their taxable income as dividends. Choose the best mix of income-producing assets for you.

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