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

Company

Recent Yield

5-Year Avg. Annual Div. Growth Rate

Payout Ratio

My Watchlist

Penn Virginia Resource Partners (NYSE: PVR) 7.2% 8.6% 227% Add
Oxford Resource Partners 7.0% New dividend NM Add
Natural Resource Partners 6.1% 9.4% 140% Add
Alliance Resource Partners (Nasdaq: ARLP) 4.8% 15.3% 48% Add
Alliance Holdings 4.2% 20.6%* 65% Add
Arch Coal (NYSE: ACI) 1.2% 10.6% 40% Add
Yanzhou Coal (NYSE: YZC) 1.1% 19.6% 16% Add
CONSOL Energy (NYSE: CNX) 0.8% 9.3% 25% Add
Peabody Energy 0.6% 8.6% 10% Add
Massey Energy (NYSE: MEE) 0.4% 11.2% NM Add
Walter Energy (NYSE: WLT) 0.4% 27.2% 7% Add

Data: Motley Fool CAPS. NM = not meaningful due to negative earnings.
* 4-year growth rate.

If you focus on dividend yield alone, you might end up with Penn Virginia Resource Partners and Oxford Resource Partners, but they're not necessarily your best bets. Penn Virginia's steep payout ratio shows that it has been paying out much more than it's earning. Oxford's dividend growth rate is still undetermined, while it has recently posted net losses.

Instead, let's focus on the dividend growth rate first, where Walter Energy leads the way. Its payout ratio leaves lots of room for growth, but with a current yield of less than 1%, it will take a while to grow to attractive levels.

Just right
As I see it, Alliance Resource Partners and Alliance Holdings give you the best of everything for a dividend stock. They sport yields of about 4% or more, healthy dividend growth rates, and reasonable payout ratios. They 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 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. Alliance Resource Partners is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.