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 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. 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 industrial machinery
Below, I've compiled some of the major dividend-paying players in the industrial machinery 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
Eaton (NYSE: ETN) 3.3% 10.4% 35% Add
Illinois Tool Works (NYSE: ITW) 3.2% 14.3% 34% Add
Graco 2.4% 7.3% 37% Add
Dover 2.3% 10.3% 27% Add
Parker Hannifin (NYSE: PH) 2.0% 14.2% 20% Add
IDEX 1.9% 9.6% 28% Add
Tennant 1.8% 6.8% 34% Add
Ingersoll-Rand 1.6% (15.1%) 42% Add
Sun Hydraulics (Nasdaq: SNHY) 1.6% 30.7% 46% Add
Flowserve (NYSE: FLS) 1.3% 20.9%* 17% Add
Graham Group (AMEX: GHM) 0.4% 17.5% 7% Add
Gardner Denver 0.3% New dividend 4% Add

Data: Motley Fool CAPS. *Denotes the past four years.

Often, if you focus on dividend yield alone, you end up with a very slow-growing dividend or a payout rate that's worrisomely high. That's not a danger among these companies, though.

Instead, let's focus on the dividend growth rate first, where Sun Hydraulics, Flowserve, and Graham Group lead the way. Their growth rates are so steep, though, that they may be hard to maintain for long, though their reasonable payout rates make that not an immediate concern. Note, though, that their current yields are on the low side, meaning that it may take a while for them to grow competitive.

You may notice, too, that some notable players in the industry, such as Stratasys (Nasdaq: SSYS), with its three-dimensional printers, aren't on the list. That's because smaller, fast-growing companies often prefer to plow any excess cash into further growth, rather than pay it out to shareholders.

Just right
As I see it, among the companies above, Eaton and Illinois Tool Works offer the best combination of dividend traits, sporting some solid income now and a good chance of strong dividend growth in the future. Sun Hydraulics and Flowserve are well worth considering, as well, due to their rapid dividend growth.

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. (Remember, too, that you may find even more attractive dividends elsewhere, such as in electric utilities or tobacco.)

Do your portfolio a favor. Don't ignore the growth you can gain from powerful dividend payers.

Looking for some All-Star dividend-paying stocks? Look no further.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.