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, ranked according to their dividend yields:
5-Year Average Annual Dividend Growth Rate
Companhia Siderurgica Nacional
Data: Motley Fool CAPS. NM = not meaningful; AK Steel started paying a dividend within the past five years.
If you focus on dividend yield alone, you might choose Companhia Siderurgica Nacional, but it's not necessarily your best bet, as its dividend growth rate isn't stellar. Its payout ratio is also enormous and worrisome, as are many in the list, but that's generally because this is a cyclical industry and earnings have been depressed recently. If you expect earnings to rebound, you can expect the payout ratios to fall.
Instead, let's focus on the dividend growth rate first, where Rio Tinto, Vale, and ArcelorMittal lead the way. Their growth rates are so steep, though, that they may be hard to maintain for long, especially in the case of Rio Tinto, where the rate is particularly high, along with the payout ratio.
Vale and ArcelorMittal have both strong growth rates and low payout ratios, making them rather attractive. But their yields are on the low side, especially Vale. That's not necessarily a deal-breaker, but the ideal stock would have a higher yield as well.
As I see it, Nucor looks the most attractive. It sports a yield of 3.3%, a healthy dividend growth rate, and a payout ratio that will look more reasonable once the company returns to previous earnings levels. ArcelorMittal is also appealing, despite its lower yield, because it seems to be aggressively increasing its payout with plenty of room to grow. These companies offer some solid income now and a good chance of strong dividend growth in the future. 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.
Do your portfolio a favor. Don't ignore the growth you can gain from powerful dividend payers.
We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. The Fool owns shares of Nucor, which is a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.