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 conglomerates 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 conglomerates
Below, I've compiled some of the major dividend-paying players that Yahoo! Finance classifies as conglomerates, ranked according to their dividend yields:
5-Year Avg. Annual Div. Growth Rate
Source: Motley Fool CAPS. NM = not meaningful because of negative earnings.
If you focus on dividend yield alone, DuPont makes the top of the list -- but its dividend is growing rather slowly.
Instead, let's focus on the dividend growth rate first, where Danaher leads the way. However, Danaher's current yield is so low that it will take a while to reach a meaningful level.
As I see it, Northrop Grumman and United Technologies offer the most promising combination of dividend traits. They sport yields of 2% to 3%, healthy dividend growth rates, and reasonable payout ratios. They offer some income now and a good chance of strong dividend growth in the future. In addition, GE looks attractive to me, despite its five-year decline in dividend payouts. A closer look reveals that while GE did slash its dividend by 68% in 2009, it has been raising it since then. The payout's now 40% higher than it was after the cut.
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."
Longtime Fool contributor Selena Maranjian owns shares of no company mentioned in this article. The Fool owns shares of Northrop Grumman and Textron. 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.
More from The Motley Fool
Northrop Grumman Stock Upgraded: What You Need to Know
JPMorgan switches out Raytheon for Northrop on its buy list.
GE Cutting 12,000 Jobs as Renewables and Energy Storage Upend Fossil Fuels
General Electric can't ignore the fact that renewable energy is crushing fossil fuels in electricity markets.
Forget General Electric Co. Stock; Honeywell International Is a Better Value
Issues in GE's power segment mean the company has a challenging near-term outlook, but its industrial peer looks set for growth.