The Most Promising Dividends in Steel and Iron

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 steel and iron 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 steel and iron
Below, I've compiled some of the major dividend-paying players in the steel and iron industry (and a few smaller outfits), ranked according to their dividend yields:

Data: Motley Fool CAPS; N/A = not applicable due to negative earnings

Dividend investors typically focus first on yield. Cliffs Natural Resources (CLF 1.85%) and ArcelorMittal (MT 0.57%) are among the highest-yielding stocks in the group, but they're not necessarily your best bets. Cliffs has been struggling along with the coal industry, and some worry that its dividend (which was doubled  last year) isn't sustainable. Still, its fortunes should change once the auto industry and others are recovering more strongly, as Cliff's metallurgical coal is used in making steel. For long-term investors, Cliffs seems attractively priced, and should pay you well to wait.

ArcelorMittal, like U.S. Steel (X -1.57%), is more vertically integrated than most peers, and thus more able to control inputs and pricing as it owns its own mines. Both are free-cash-flow positive -- ArcelorMittal more so, but both also carry significant debt. Note, too, that the dividends of both are down from where they were a few years ago, and the companies have recently been posting net losses instead of gains.

Remember that in tough times, dividends often don't grow, and sometimes even get suspended, as happened with AK Steel Holding (AKS). Like other steel companies, it has been struggling with low steel prices and significant debt.

Instead, let's focus on the dividend growth rate first, where Cliffs and Companhia Siderurgica Nacional (SID 2.54%) lead the way. Such steep growth rates can be hard to maintain for long, though. Companhia Siderurgica Nacional, for example, has seen its net income drop sharply lately, so that its dividend payout now far exceeds its income. Its last quarter  featured sales growth, however, and increased volume, which is promising.

Nonetheless, all of these companies can see their fortunes change sharply once the global economic recovery strengthens.

Just right
As I see it, Cliffs Natural Resources and ArcelorMittal offer the most compelling combination of dividend traits, sporting some solid income now and a decent chance of dividend growth in the coming years. Companhia Siderurgica Nacional is also worth considering, and Nucor has long been a favorite of many investors, who have been impressed with its innovative ways and performance.

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.