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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 pollution and treatment controls 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 it 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 pollution and treatment controls
Dividend investors typically focus first on yield. Radiation exposure specialist Landauer, for example, has one of the highest yields among pollution and treatment controls companies, recently offering 3.9%. But it's not necessarily your best bet, as its five-year average dividend growth rate is below 4% and its payout ratio is 92%, suggesting there isn't a lot of room for growth. Progressive Waste Solutions, meanwhile, yields around 2.8%, but its dividend has been falling in recent years.
Instead, let's focus on the dividend growth rate first, where contaminant remover Pall (NYSE: PLL ) and filtration specialist Donaldson (NYSE: DCI ) lead the way, both with a five-year average annual dividend growth rate of 10%. Pall's 1.7% yield is more attractive than Donaldson's 1.1% yield, but Pall's recent earnings report was a bit of a mixed bag, with revenue down and earnings up, and net margins up while operating margins were down. Global economic conditions have been blamed, but the company remains poised to benefit from its emerging-market operations when the world's economies heat up. Donaldson, though, has been delivering accelerating revenue and earnings growth, while adding facilities in China and raising its performance expectations.
Some notable players in the industry, such as Metalico (NYSE: MEA ) and Westport Innovations (Nasdaq: WPRT ) , aren't on the list. That's because smaller, fast-growing companies often prefer to plow any excess cash into further growth, rather than pay it out to shareholders. Metalico's scrap metal recycling business is enjoying average annual revenue growth of 17% over the past five years, but so far it remains a small penny stock. Westport, serving the burgeoning natural gas fuel industry, sports a five-year average revenue growth rate of 33%. It's a bigger company, securing deals with the likes of Ford and Volvo.
As I see it, none of the companies in the industry offer a perfect combination of dividend traits, sporting some solid income now and a good chance of strong dividend growth in the future, along with a reasonable payout ratio. One that comes close is Pentair (NYSE: PNR ) , recently yielding 2.1% with a 7% growth rate. Its payout ratio is worrisome, but a big uptick in earnings can take care of that. Bulls are excited about the company's acquisition of Tyco's flow control business.
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.
Do your portfolio a favor. Don't ignore the growth you can gain from powerful dividend-payers. To be introduced to some additional strong contenders, check out our special free report, "Secure Your Future With 9 Rock-Solid Dividend Stocks."