Dividend payers deserve a berth in any long-term stock portfolio. But seemingly attractive dividend yields are not always as appealing as they may appear. Let's see which companies in the domestic telecom services 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 domestic telecom services
Below, I've compiled some of the major dividend-paying players in the domestic telecom services industry (and a few smaller outfits), ranked according to their dividend yields:
5-Year Avg. Annual Div. Growth Rate
Alaska Communications Systems
Source: Motley Fool CAPS. NM = not meaningful due to negative earnings.
*Three-year average annual dividend growth rate.
If you focus on dividend yield alone, you might end up with Alaska Communications and Consolidated Communications, but they're not necessarily your best bets. Their dividend growth rates are paltry, and their payout ratios are either high or meaningless because of losses.
Instead, let's focus on the dividend growth rate first, where CenturyLink leads the way. Its growth rate is so steep, though, that the company can't keep it up for long. And the slight steepness of its payout ratio should also concern investors.
As I see it, out of this bunch, AT&T gives you the best of everything for a dividend stock. It sports a yield around 6%, a not-insignificant dividend growth rate, and a reasonable payout ratio. Verizon is also appealing if you expect its income to rise as it rolls out the new Verizon iPhone. These companies some solid payouts now, with a good chance of strong dividend growth in the future.
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
We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
More from The Motley Fool
3 Dividend Stocks That Pay You Better Than ExxonMobil Does
If you need more income than ExxonMobil's 3.7% dividend yield, here are three alternatives.
3 High-Yield Tech Stocks
These tech stocks are outliers in a sector that often shuns dividends.
10 Highest-Yielding Dividend Stocks: Are Any Worth Buying
These companies offer the fat payouts income investors love, but all too often, extra-high yields are a danger signal.