Dividend payers deserve a berth in any long-term stock portfolio. But seemingly attractive dividend yields are not always as alluring as they may appear. Let's see which companies in the medical instruments and supplies 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:

  1. The current yield
  2. The dividend growth
  3. 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, provided 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 own 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 medical instruments and supplies
Below, I've compiled some of the major dividend-paying players in the medical instruments and supplies industry (and a few smaller outfits), ranked according to their dividend yields:

Company

Recent Yield

5-Year Avg. Annual Div. Growth Rate

Payout Ratio

Baxter International (NYSE: BAX) 2.5% 15.4% 44%
Becton Dickinson (NYSE: BDX) 2.0% 15.5% 27%
Covidien (NYSE: COV) 1.7% 7.6%* 28%
Alcon 1.4% 24.7% 31%
Stryker (NYSE: SYK) 1.3% 43.0% 22%
Mindray Medical International (NYSE: MR) 1.2% 10.1%* 12%
PerkinElmer 1.1% 0.0% 24%
Hill-Rom Holdings 1.1% (21.5%) 21%
C. R. Bard 0.8% 6.6% 14%
DENTSPLY International (Nasdaq: XRAY) 0.6% 11.5% 11%
Cantel Medical (NYSE: CMN) 0.6% N/A** 9%

Data: Motley Fool CAPS.
*Past three years.
**Newly initiated dividend, raised 20% for most recent declared dividend.

If you focus on dividend yield alone, you might end up bypassing all of these companies -- but that would be a short-sighted approach.

Take a look at the dividend growth rates, and you'll see that some of these payouts are growing briskly, with Stryker and Alcon leading the way. Their growth rates are steep enough to raise concerns that these increases may be hard to maintain. But with their low payout ratios, they won't necessarily run out of steam too quickly.

Just right
As I see it, Baxter International and Becton Dickinson give you the best of everything for a dividend stock. They sport yields of at least 2%, healthy dividend growth rates, and low payout ratios. They offer some 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, 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 get more ideas for great dividend-paying stocks, read about "13 High-Yielding Stocks to Buy Today."

Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. Becton Dickinson, Covidien, and Stryker are Motley Fool Inside Value picks. Mindray Medical International is a Motley Fool Rule Breakers recommendation. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.