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 water utility 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 water utilities
Below, I've compiled some of the major dividend-paying players in the water utility industry (and a few smaller outfits), ranked according to their dividend yields:
5-Year Avg. Annual Div. Growth Rate
Connecticut Water Service
California Water Service Group
American Water Works
American States Water
Source: Motley Fool CAPS.
*Over past two years.
If you focus on dividend yield alone, you might end up with Middlesex Water and Artesian Resources, but they're not necessarily your best bets. Their dividend growth rates aren't stellar, particularly Middlesex's.
Instead, let's focus on the dividend growth rate first, where Veolia Environnement leads the way. Alas, its growth rate is so steep that it may be hard to maintain for long, especially given its high payout ratio.
As I see it, Aqua America offers a compelling combination, sporting a yield close to 3%, a respectable dividend growth rate, and a reasonable payout ratio. It offers some income now and a good chance of dividend growth in the future. American Water Works and SJW also look attractive, with slightly higher dividends and lower payout ratios, despite having slower dividend growth.
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 of great dividend-paying stocks, read about "13 High-Yielding Stocks to Buy Today."
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. California Water Service Group and Aqua America are Motley Fool Income Investor picks. The Fool owns shares of California Water Service Group. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.