In the world of finance, companies that dole out hefty dividends often have a reputation for being the stalwarts of stability and maturity. These firms typically channel their investments into sustaining their tried-and-true business models, allowing them to shower their shareholders with surplus profits.

But before you pop the champagne over a juicy dividend yield, remember that there's more to this defensive strategy than meets the eye. Simply eyeing the dividend yield—the ratio of the dividend to the share price—won't cut it. The real challenge lies in assessing whether the company boasts robust fundamentals. Only with a strong foundation can a company hope to maintain or even boost its dividend payouts in the future. Without this, the strategy is as flimsy as a house of cards. Let's have a look at two multinational European companies that I think offer a good case study.

Example of an unsuccessful dividend investment: Orange

Dividend and yield trends (source: MarketScreener)

On paper, the telecommunications group's dividend offers a high yield, every year at least in excess of 4.5%. The coupon is stable at 70 cents per share. Quite attractive at first glance, isn't it?

But at the same time, between 2018 and 2023, the Orange share price fell by almost 30%. There are many reasons for this: difficulty in holding on to market share due to intense competition, a model in decline, sustained investment to stay at the forefront of innovation, margins under pressure due to price cuts, no growth, no market concentration, etc.

Orange underperformed the French indice CAC 40 between the beginning of 2018 and the end of 2023 (source: MarketScreener)

If we add dividends, the picture is less bitter. The investment actually returned 2.3% to the investor over 5 years... When you consider that cumulative inflation over the period reached 16%, the pill is hard to swallow.

Example of a successful dividend investment: Rio Tinto

In 2021, the mining group paid an exceptional dividend after a record year (source: MarketScreener)

Rio Tinto is one of the world's leading players in the mining sector. The business is mature. Growth is weak and depends mainly on the cyclicality of metal prices. Margins are high and barriers to entry are high for potential new competitors. Its presence is worldwide. Its cost structure is optimal, and the Group has substantial financial resources, such as the payment of an exceptional dividend in 2021 and the purchase of Arcadium Lithium this year for $6.7 billion.

Excluding dividends, Rio Tinto's share price rose by almost 50% over the period. It's almost as if we were looking at a great growth stock.

Dividends make the rise much stronger!

In short, when it comes to investing in stocks for dividends, it's essential to look beyond the simple dividend yield, which alone doesn't justify the investment. Above all, it's important to focus on companies that are in good health, have a competitive edge for the years ahead, and are capable of increasing their payout to shareholders (dividends and/or share buybacks) without damaging their balance sheet.