Investors, particularly those on fixed incomes for whom safety of principal is important, are more likely to buy common stocks that pay dividends. Thepotential for regular increases in dividends is attractive when compared to the fixed-income payments bonds and preferred stocks provide.

If you invest in dividend-paying common stocks, you should exercise caution when choosing a stock on the basis of an attractively high dividend. Somecompanies whose dividends are enticingly high today may not be able to boost those dividends for a long time. They may even have to cut their dividend ifearnings are off.

What, then, are the criteria you should use in measuring a particular dividend-paying stock? You want, above all else, to ensure the consistency of your dividend payments. You also want your dividends to increase on aregular basis. Moreover, you would like to see that the company you invest inhas reasonable prospects for earnings growth.

There are yardsticks that you can use to give you a better idea of a company’s financial health and its continued ability to pay dividends. Whilenot foolproof, they will give you a clearer understanding of what to look for in picking an income stock. When you examine an income stock, you shouldcheck if the company has a record of uninterrupted earnings and dividend growth over the years. You should examine the company’s prospects forfuture dividends growth. Be wary where a company pays out as dividendsmore than it earns.

And look also at the stock’s price/earnings (P/E) ratio. The P/E ratio isessentially a measure of investor confidence in a particular stock. Askyourself where the company stands in terms of current earnings and future prospects. How high or low is the P/E ratio when compared to other stocks inthe same industry? Certain companies have historically performed well on a consistent basis no matter whether the economy is in a boom or a bust cycle. Utilities have beena good example. Gas, electric, telephone, and water companies on the wholehave tended to exhibit steady, dependable growth and consistent increases in dividends. You can measure the credit quality of utility and telephonecompanies by checking how they are rated by ratings services such as Moody’s and Standard & Poors.

Many stocks in groups other than utilities pay dividends that increase regularly. Many Fortune 500 firms show steady, reliable earnings growth andprovide consistent dividends. Industries that provide basic commodities,products, and services tend to hold their own even during downturns in the economy. However, even Fortune 500 firms are subject to the swings of avolatile stock market.

Inflation and high interest rates are other concerns for investors in dividend- paying stocks. You should know that the prices of income stocks tend to fallin times of high inflation and high interest rates. However, their dividendstend to move up in tandem with the level of inflation. In all, successfulinvesting for income requires time, patience, and good advice.

ALAN S. MOORE writes this column every Wednesday for L’Observateur. He isa financial advisor with of Legg Mason Wood Walker, Inc., a diversifiedsecurities brokerage and financial services firm that is a member of the New York Stock Exchange, Inc.

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