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 medical equipment 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 medical equipment
Below, I've compiled some of the major dividend-paying players in the medical appliances and equipment 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

Shamir Optical (Nasdaq: SHMR) 5.8% Irregular but growing 92% Add
Mine Safety Appliances (NYSE: MSA) 2.8% 13.3% 94% Add
Medtronic (NYSE: MDT) 2.2% 19.5% 29% Add
Smith & Nephew (NYSE: SNN) 1.7% 8.6% 21% Add
Steris 1.7% 50.9% 75% Add
St. Jude Medical (NYSE: STJ) 1.6% New dividend 31% Add
Invacare 0.2% (4.0%) 5% Add

Data: Motley Fool CAPS.

If you focus on dividend yield alone, you might end up with Shamir Optical and Mine Safety, but they're not necessarily your best bets. Their payout ratios indicate that they're paying most of their earnings out as dividends.

Instead, let's focus on the dividend growth rate first, where Steris and Medtronic lead the way. However, Steris's growth rate is so steep that it may be hard to maintain for long. While Steris's payout ratio approaches a high level, Medtronic's remains low, offering more room for dividend growth.

You may also notice that some players in the industry, such as Accuray (Nasdaq: ARAY) and Intuitive Surgical (Nasdaq: ISRG), aren't on the list. With a market cap below $1 billion, Accuray needs to plow excess cash into further growth instead of paying it out to shareholders. Intuitive Surgical may be a much bigger company than Accuray, but it's still in a rapid growth phase as well.

Just right
As I see it, within this group, Medtronic gives you the best dividend combination, offering some income now and a good chance of strong dividend growth in the future. Many of the others are worth watching, too. For example, even if Shamir Optical's dividend doesn't grow too quickly (and it might, for a while), its current yield is very attractive.

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 Intuitive Surgical. Intuitive Surgical is a Motley Fool Rule Breakers recommendation. Smith & Nephew is a Motley Fool Global Gains pick. The Fool owns shares of Medtronic. 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.