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


Recent Yield

5-Year Avg. Annual Div. Growth Rate

Payout Ratio

Add to Watchlist


American Software (Nasdaq: AMSWA)





Microsoft (Nasdaq: MSFT)





OPNET Technologies (Nasdaq: OPNT)


New dividend








CA Technologies





Oracle (Nasdaq: ORCL)


New dividend



Source: Motley Fool CAPS.

If you focus on dividend yield alone, you might end up with American Software, but it's not necessarily your best bet, as its payout far exceeds its earnings over the past 12 months.

Instead, let's focus on the dividend growth rate first, where Microsoft and SAP stand out. It's important to note that Microsoft's current yield is much higher than SAP's, making Microsoft look even more attractive with its faster growth rate.

You may notice, too, that some players of interest in the industry, such as China Digital TV (NYSE: STV), F5 Networks (Nasdaq: FFIV), and Nuance Communications (Nasdaq: NUAN), aren't on the list. While China Digital is a relatively small company, with a market cap recently near $400 million, and F5 and Nuance are both between $6 billion and $9 billion, all are busy growing and would rather apply any excess cash to that growth than pay it out to shareholders.

Just right
As I see it, among the companies above, Microsoft sports the best combination for a dividend stock, offering solid income now and a good chance of strong dividend growth in the future. The others bear watching, though, as they're the kind of dynamic companies that can grow into more stable behemoths able to pay dividends. After all, Microsoft's dividend began just in 2003, and Oracle's in 2009.

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."