There is no question that one of the safest and surest ways to build long-term wealth in the stock market is through dividend reinvestment. This reinvestment allows for a form of interest compounding to take place that builds up the portfolio’s value over time.

#-ad_banner-#While this makes perfect investing sense, there is more to it than simply buying high-dividend stocks. I learned this the hard way, but my experience helped me to develop an easy three-step method to determine the best dividend-paying stocks for a dividend reinvestment portfolio.

First, here’s what happened to me.

I bought Sandridge Mississippian Trust (NYSE: SDT), an oil and gas royalty-earning company that pays a tremendous dividend, in February 2013 at $14. At the time of my purchase, the dividend yield was around 10%. The yield is now over 20% — yet I lost money on the investment. SDT has dropped 50% over the past year, to its current trading range near $7.

My buy decision was based purely on the high dividend yield, nothing else. What I failed to take into consideration is the fact that yield is a function of the stock price. With everything else being equal, the lower the share price, the higher the yield. This means that a steadily increasing dividend yield may be due to a decreasing share price.

With these points understood, just what makes a dividend stock the best? To answer this question and provide a framework for choosing dividend-paying investments while avoiding questionable high yielders, I developed a universal three-step screening process.

	Flickr/Aaron Friedman
	Knowing that Warren Buffett or another proven large investor holds shares of a particular dividend paying stock lend tremendous credence to the investment.

1. Solid Companies with Market-Dominating Products/Services
It makes sense that your long-term dividend reinvestment portfolio comprise companies with solid long-term histories. Avoid the “flavor of the month” firms and other companies lacking a historical record through various economic cycles. The fundamental picture should also indicate steady growth in basic metrics such as revenues, profits and cash on hand.

2. Consistent History of Dividend Increases
Consistent dividend increases over a period of many years reflect a company that is able to produce excess cash in a variety of economic situations. In other words, a company that is profitable despite the ups and downs of the economy. This type of proven flexibility is critical when looking for future success in any investment.

3. The Buffett Factor
Do successful hedge funds and other proven large investment gurus hold substantial positions in the stock? Large investors have substantial resources to conduct research and due diligence into all of their investments. This ability goes far beyond most every individual investor skill. Knowing that Warren Buffett or another proven large investor holds shares of a particular dividend paying stock lend tremendous credence to the investment.

Here are my two top dividend-paying stocks fitting the above strategy

1. Wal-Mart (NYSE: WMT )

The world’s largest retailer, Wal-Mart has a market cap of $234 billion and is valued at just less than 14 times earnings. WMT currently yields 2.6 and pays out 39% of its income as dividends. Buffett owns just over 49 million shares worth more than $3.5 billion. During fiscal year 2014, Wal-Mart returned nearly $13 billion to shareholders in the form of dividends and share buybacks. It has posted 41 consecutive years of dividend increases. However, WMT is having a difficult time breaking resistance at $75. This has formed a bearish double top on the daily chart at that level. Technical support exists in the $71 to $72 area. Based on the technical picture, I would purchase shares when $75 is violated on the upside on the daily close.

2. Coca-Cola (NYSE: KO )

I really like Coca-Cola as a long term-investment. Having recently written about a unique pairs trade involving Coca-Cola and Green Mountain Coffee Roasters (Nasdaq: GMCR), I am pleased to report both sides of the trade are currently solidly profitable. KO is currently yielding 3.2%. A payout ratio of 59% and over $20 billion in total cash creates a compelling case for future dividend increases. The company has paid a quarterly dividend since 1920 and has increased its dividend every year for the last half-century. Buffett holds about 400 million shares, clearly indicating his support of the company. Buying shares now in the $38 to $39 area makes solid investing sense.

Risks to Consider: The stock market is full of risks. Even if a company passes my three-step screen with flying colors there is still risk of loss. While the screen lowers the risk, it in no way eliminates it. Always use stop-loss orders and diversify when investing.

Action to Take –> While Coca-Cola and Wal-Mart are my two favorite long-term dividend reinvestment stocks, there are numerous other companies that meet the screens criteria. When deciding on what stocks to put into your dividend portfolio, make certain they pass the three-step screen.

P.S. Stocks like KO are exactly the kinds of investments my colleague Dave Forest looks for every day in his premium advisory Top 10 Stocks. In fact, Dave found a company similar to Coca-Cola that he thinks has even more potential — so much so that he named it one of his Top 10 stocks for 2014. To learn how to get this report as well as a list of his absolute top stocks to own this year, click here to read this special report.