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 industrial electrical 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. 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, and 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' expansion, pay off debt, buy back shares, or even purchase 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 industrial electrical equipment
Below, I've compiled some of the major dividend-paying players in the industrial electrical equipment 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

Eaton (NYSE: ETN) 2.7% 10.5% 38% Add
AZZ (NYSE: AZZ) 2.3% New dividend 36% Add
ABB (NYSE: ABB) 1.8% 46.8% 39% Add
Rockwell Automation (NYSE: ROK) 1.7% 6.6% 34% Add
A.O. Smith 1.4% 4.9% 21% Add
Daktronics (Nasdaq: DAKT) 1.0% 40.8% 400% Add
AMETEK 0.6% 10.1% 10% Add
Belden 0.6% 0.0% 8% Add

Data: Motley Fool CAPS.

Eaton and AZZ have the highest dividend yields. But AZZ doesn't have a very long dividend track record to suggest how rapidly the payout may grow.

So let's also take a look at the dividend growth rate, where Daktronics and ABB lead the way. Their growth rates are so steep, though, that they will be hard to maintain for long. And the fact that Daktronics' payout ratio exceeds 100% is also a red flag.

You may notice, too, that some notable players in the industry, such as Capstone Turbine (Nasdaq: CPST), FuelCell Energy, and GrafTech International (NYSE: GTI), aren't on the list. That's because smaller, rapidly growing companies often prefer to plow any excess cash into further growth rather than pay it out to shareholders, and Capstone and FuelCell in particular are small companies, with market caps below $500 million. GrafTech's value is around $3 billion, and some observers expect that number to rise significantly once demand for steel and the company's graphite electrodes picks up.

Just right
As I see it, among the companies above, Eaton sports the best combination of dividend traits, with ABB and AZZ also meriting a closer look. They all offer some solid income now and a 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. The Motley Fool owns shares of GrafTech International and AZZ. Motley Fool newsletter services have recommended ABB. 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.