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

Company

Recent Yield

5-Year Avg. Annual Div. Growth Rate

Payout Ratio

Illinois Tool Works (NYSE: ITW) 2.5% 18.2% 43%
Eaton (NYSE: ETN) 2.5% 11.3% 40%
Graco (NYSE: GGG) 2.0% 8.8% 52%
Dover 1.7% 10.4% 29%
Tennant 1.6% 5.8% 44%
IDEX 1.5% 10.0% 30%
Parker Hannifin 1.4% 13.6% 21%
Sun Hydraulics (Nasdaq: SNHY) 0.9% 20.1% 37%
Flowserve (NYSE: FLS) 0.9% 17.9%* 17%
Ingersoll-Rand (NYSE: IR) 0.6% 0.1% 27%
Graham Group (AMEX: GHM) 0.3% 16.1% 21%
Gardner Denver 0.3% New dividend 7%

Source: Motley Fool CAPS.
*Four-year growth rate.

Focusing on dividend yield alone may seem obvious. But companies with high yields aren't automatically your best bet. Without other factors, a high yield can disappear in a hurry.

Instead, let's focus on the dividend growth rate first, where Sun Hydraulics and Flowserve, among others, stand out. Their growth rates are so steep that they may be hard to maintain for long -- though their low payout ratios don't have me too worried at this point. But their current yields are rather low. You could do better.

Just right
As I see it, Illinois Tool Works gives you the best of everything for a dividend stock. It sports a respectable yield, a strong dividend growth rate, and a low payout ratio. Eaton is also attractive, though with a slightly lower growth rate. These companies offer 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, 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 owns shares of Graham Group. Tennant is a Motley Fool Stock Advisor choice. Sun Hydraulics is a Motley Fool Hidden Gems selection. Illinois Tool Works is a Motley Fool Income Investor 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.