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 diversified utility 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:
- 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 diversified utilities
Below, I've compiled some of the major dividend-paying players in the diversified utilities industry (and a few smaller outfits), ranked according to their dividend yields:
5-Year Avg. Annual Div. Growth Rate
Add to Watchlist
|PG & E||4.2%||7.9%||69%||Add|
|Public Service Enterprise Group||4.1%||4.4%||46%||Add|
Source: Motley Fool CAPS. *Past four years.
Focusing on dividend yield alone is tough when all of these companies have roughly similar yields. Moreover, their payout ratios all suggest sustainable dividend rates. However, the companies distinguish themselves in dividend growth, with some growing their dividends very slowly or not at all, while others expand much more quickly. The highest-yielding companies in this group are not unattractive, but several even more compelling companies await you further down the list.
As I see it, among these companies, DPL and Avista offer the best combination of dividend traits, with Exelon and Westar deserving serious consideration as well. With yields topping 4%, healthy dividend growth rates, and reasonable payout ratios, they all offer some 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 for great dividend-paying stocks, read about "13 High-Yielding Stocks to Buy Today."