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Dividend payers deserve a berth in any long-term stock portfolio. But seemingly attractive dividend yields are not always as fetching as they may appear. Let's see which companies in the scientific and technical instrument industry offer the most promising dividends.
Yields and growth rates and payout ratios, oh my!
Before we get to those companies, though, you should understand just why you'd want to own dividend payers. These stocks can contribute a huge chunk of growth to your portfolio in good times, and bolster it during market downturns.
As my colleague Matt Koppenheffer has noted: "Between 2000 and 2009, the average dividend-adjusted return on stocks with market caps above $5 billion and a trailing yield of 2.5% or better was a whopping 114%. Compare that to a 19% drop for the S&P 500."
When hunting for promising dividend payers, unsophisticated investors will often just look for the highest yields they can find. While these stocks will indeed pay out the most, the yield figures apply only for the current year. Extremely steep dividend yields can be precarious, and even solid ones are vulnerable to dividend cuts.
When evaluating a company's attractiveness in terms of its dividend, it's important to examine at least three factors:
- The current yield
- The dividend growth
- The payout ratio
If a company has a middling dividend yield but a history of increasing its payment substantially from year to year, it deserves extra consideration. A $3 dividend can become $7.80 in 10 years, if it grows at 10% annually. (It will top $20 after 20 years.) Thus, a 3% yield today may be more attractive than a 4% one, if the 3% company is rapidly increasing that dividend.
Next, consider the company's payout ratio, which reflects what percentage of income the company is spending on its dividend. In general, the lower the number, the better. A low payout ratio means there's plenty of room for generous dividend increases. It also means that much of the company's income remains in its hands, giving it a lot of flexibility. That money can fund the business's expansion, pay off debt, buy back shares, or even buy other companies. A steep payout ratio reflects little flexibility for the company, less room for dividend growth, and a stronger chance that if the company falls on hard times, it will have to reduce its dividend.
Peering into scientific and technical instruments
Dividend investors typically focus first on yield, but it's important to consider how rapidly a company's dividend is growing, as well. Garmin (Nasdaq: GRMN ) recently yielded 3.8%, with a five-year average annual dividend growth rate of 25%. That's too fast to be sustainable over the long run, but with a payout ratio near 60%, it's not an immediate concern. The company has many of the markings of a perfect stock, though some worry about competition from smartphones equipped with navigation systems.
Some scientific and technical instrument companies don't pay dividends at all. That's because smaller or fast-growing companies often prefer to plow any excess cash into further growth, rather than pay it out to shareholders. Examples include ION Geophysical (NYSE: IO ) , for example, with a market cap below $1 billion, and Cepheid (Nasdaq: CPHD ) , valued around $2.5 billion. ION Geophysical serves the oil exploration industry, helping collect and process seismic data. With the price of natural gas so low lately, more energy companies are focusing on oil, seeking heftier profit margins. Cepheid, meanwhile, makes DNA detection systems, and has some wondering if it might get bought out.
Even some large companies don't offer dividends if their management believes it has better uses for the money, or isn't confident enough in the income stream to commit to a regular payout. Agilent Technologies (NYSE: A ) , for example, only initiated a regular dividend in 2012. Spun off from Hewlett-Packard, it makes bio-analytical measurement systems, among other things, and sports an accelerating revenue growth rate, along with net margins topping 15%.
As I see it, Garmin and MTS Systems (Nasdaq: MTSC ) offer the best combination of dividend traits, sporting some solid income now and a good chance of strong dividend growth in the future. MTS Systems has recently been under investigation regarding compliance issues, but I don't see that as likely to create a long-term problem for the company. In the meantime, it's authorized to buy back up to 16% of its shares of stock, which would significantly boost the value of remaining shares.
Of course, as with all stocks, you'll want to look into more than just a company's dividend situation before making a purchase decision. Still, these stocks' compelling dividends make them great places to start your search, particularly if you're excited by the prospects for this industry. Remember, too, that you may find even more attractive dividends elsewhere, such as in foreign wireless companies or gas utilities.
Do your portfolio a favor. Don't ignore the growth you can gain from powerful dividend payers.
Looking for some All-Star dividend-paying stocks? Look no further.