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 farm and construction 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.

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

Company

Recent Yield

5-Year Average Annual Dividend Growth Rate

Payout Ratio

Add to Watchlist

Nacco (NYSE: NC) 2.1% 2.6% 22% Add
Cascade (NYSE: CASC) 1.9% 5.9% 14% Add
Caterpillar (NYSE: CAT) 1.6% 14.1% 41% Add
Deere (NYSE: DE) 1.5% 13.3% 25% Add
Alamo Group 0.9% 0.0% 13% Add
Joy Global (Nasdaq: JOYG) 0.7% 13.5% 15% Add
Lindsay (NYSE: LNN) 0.5% 6.7% 15% Add
Manitowoc (NYSE: MTW) 0.4% 3.3% NM Add
Bucyrus International 0.1% 4.4% 3% Add

Data: Motley Fool CAPS.
NM = Not material because of negative earnings.

If you focus on dividend yield alone, you might end up with Nacco and Cascade, but they're not necessarily your best bets. Despite topping the list in yield, they haven't grown their dividends very strongly. Over time, a stock with faster dividend growth can end up yielding more than slower-growing dividend stocks. And although some fast-growing stocks end up paying out too much of their earnings in dividends, these stocks have plenty of room to raise their payouts, as their low payout ratios show.

Just right
As I see it, in this group, Caterpillar and Deere give you the best dividend-trait combination. They offer some 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 no shares of any companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.