Word of mouth is without a doubt the most reliable way of finding out what's good, provided that you know the person you're asking and can account for their personal tastes. Most of the serious readers we've asked say they trust nothing but the opinions of other readers. With the advent of the internet, this informal network of grassroots opinion has taken a major step towards formality, and increased enormously in scale. Sites like Douban are based around the sharing of information and opinions, and are a good place for like-minded readers to exchange information.
The rationale for this site's existence is partially to address this problem: it's very hard to get a sense for the lay of the land unless you know someone in the know. Try talking to professors or students of Chinese literature, and meet more readers of Chinese!
In most countries, resources like best-seller lists, book reviews and literary prizes are all excellent ways to gain a rough understanding of what exists in terms of quality literature. In China, however, all these sources of information should be approached with skepticism.
Best-seller lists are compiled by a variety media outlets such as newspapers or magazines, and there is no one list that is widely acknowledged as authoritative. Sales figures for books are incomplete and untrustworthy to the point of being nearly meaningless, as publishing houses rarely release their own sales statistics, and there are no third parties who keep track of these sorts of things. Furthermore, the likelihood of editors and publishing houses directly meddling with the lists themselves is high enough that such lists are best ignored.
Book reviews are most often written by the publishers of the books in question, and placed in magazines and newspapers by way of a bribe to the editors. Even in cases where the reviews are written by a serious, professional reviewer, the perception of corruption is so prevalent that most readers disregard the reviews altogether. There is no Chinese equivalent of the New York Times Book Review or the London Review of Books.
While reviews and bestseller lists fall prey to commercial interests, China's literary prizes are often stifled by political control. All literary prizes in China (the most influential being the Mao Dun Literary Prize and the Lu Xun Literary Prize) are administered by the Writers Association, a government body with central and local branches, and as such tend to be awarded to books and writers in favor with the government. These prizes are still worth considering, however: they are never awarded to bad writing, and sometimes even controversial authors (有争议性, political shorthand for authors who don't toe the Party line) can win. The Writers Association and its prizes exist within the ambivalent penumbra of government control — some members are pure Party hacks, but some genuinely love literature, and there is tension and conflict both within the organization and often among the members themselves. Non-mainstream writers are quick to dimiss the prizes, but they still constitute major cultural signposts.