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 aerospace and defense industry offer the most promising dividends.
Yields and growth rates and payout ratios, oh my!
Before we get to those companies, however, you should understand just why you should 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 this 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 aerospace and defense
Below are the major players in the aerospace and defense industry. I've ranked them according to their dividend yields.
5-Year Avg. Annual Div. Growth Rate
Data: Motley Fool CAPS.
If you focus on dividend yield alone, you might end up with Lockheed Martin and Raytheon, but high yields are not necessarily your best bets. Raytheon's dividend growth rate is considerably lower than Lockheed's, for instance.
Instead, let's focus on the dividend growth first, where L-3 Communications and Lockheed Martin lead the way. Their growth rates are so steep, though, that they may be hard to maintain for long. If their payout ratios were higher, I'd worry more about this.
Fortunately, many companies in the table satisfy on all three counts: Lockheed Martin, Northrop Grumman, Boeing, General Dynamics, and L-3 Communications all sport dividend yields greater than 2%, growth rates above 10%, and payout ratios below 40%. Thus, they all offer solid income now, with a good chance of strong dividend growth ahead. Lockheed Martin seems the most attractive of them all, as long as it can keep up its dividend growth over the coming years.
Do your portfolio a favor. Don't ignore the growth you can gain from powerful dividend payers.
To get more ideas for great dividend-paying stocks, read about "13 High-Yielding Stocks to Buy Today."