Fool's School

You may have heard that dividend stocks have significantly outperformed their stingier counterparts since 1972. You may have heard that the majority of the market's historical gains have come from dividends. And you may have heard that dividend payers are the best stocks to own during bear markets. It's all true.

But dividend investing isn't all gumdrops and rainbows. Fully 374 companies reduced their dividends in 2008. And more dividends were cut by S&P 500 companies in the first quarter of 2009 than in all of 2008.

To avoid the next dividend implosion, you've got to keep an eye on a dividend payer's overall strength — and its ability to keep paying those vaunted dividends. So as you're looking for dividend stocks for a bear market, keep an eye out for red flags: extremely high yield, industry headwinds, a spotty track record and a high payout ratio.

A dividend yield that seems too good to be true usually is, because it's probably due to the stock having plunged in price, with few investors believing in it. If an industry comes under attack — as happens in cyclical industries and during economic crises — there may not be any earnings to distribute, leading to dividend cuts or suspensions. Automakers and banks are good recent examples of that.

Companies with checkered histories of dividend payments aren't the strongest candidates for investment — especially in a bear market, when external factors may strain their resources. Fortunately, many companies sport long dividend histories, demonstrating their reliability. McDonald's, for example, has paid a dividend each year since 1937.

A company's payout ratio — calculated by dividing annual dividends by net income — can help you determine whether it can afford to continue paying its dividend. A high ratio suggests the company is returning most of its earnings to shareholders, with little left over for other uses.

To see which healthy and growing dividend payers we've recommended (many with yields topping 8 percent), take advantage of a free trial of our Motley Fool Income Investor newsletter at www. incomeinvestor.fool.com.