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. You may be drawn to conglomerates because of the operational and geographical diversification they offer. Let's see which companies among conglomerates 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 reasonable 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% yield 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 conglomerates
Dividend investors typically focus first on yield. Macquarie Infrastructure (NYSE:MIC) is among the highest-yielding stocks in conglomerates, recently offering 5.9%. But it's not necessarily your best bet, as its payout ratio is a bit on the steep side, at 85%, suggesting that there isn't much room for rapid growth. The company offers a wide range of services, such as parking and hangar services at airports, waste distribution, and even the manufacturing and distribution of gas products. Its stock got a nice bump in August, when the company reported estimate-topping cash flow and raised its projections for 2012.
Let's focus on the dividend growth rate instead, where Danaher, United Technologies (NYSE:UTX), and Raven Industries (NASDAQ:RAVN) lead the way with five-year average annual dividend growth rates of 16.1%, 11.4%, and 11.4%, respectively. Danaher's recent yield was just 0.2%, though, so the rapid growth will not produce a substantial payout for a while. United Technologies and Raven Industries share a similar growth rate, but their recent dividend yields were 2.7% and 1.4%, respectively, making the former more attractive on a dividend basis. Bulls like United Technologies' purchase of Goodrich, and though the company has been hurt by slowdowns in Europe and China, it seems poised to prosper in the near future.
In its second quarter, Raven posted revenue growth of 13% and an earnings dip of 7% over year-ago levels, with the dip attributed to weakness in its Aerostar division and bumpiness in federal spending. In a conference call, management noted that a single-year drought shouldn't hurt its agricultural division too much, but if it stretches over multiple years, it could have an adverse impact. Overall, it said, "We are adjusting our plan to actively improve long-term prospects while we look to mitigate the impact on our shorter-term operating results."
As I see it, Honeywell (NYSE:HON) and United Technologies offer the best combination of dividend traits, sporting some significant income now and a good chance of solid dividend growth in the future. Honeywell serves both the commercial and military aerospace industry, and while the former is growing, the latter is threatened by spending pullbacks. A stronger global economic recovery would propel Honeywell.
If you're more interested in income than growth, consider Macquarie or Northrup Grumman (NYSE:NOC), which offer strong payouts but slow or uncertain dividend growth. Northrup Grumman is also challenged by military cutbacks, but its relatively low valuation is attractive. The folks at GMI Ratings, however, have expressed concerns over its governance, though they've noted some improvement in its accounting.
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.
Another big conglomerate to consider is General Electric, which yields around 3% and has been boosting its payout after slashing it a few years ago. Learn about its opportunities and risks in our new premium report on GE, in which our industrials analyst breaks down GE's multiple businesses. It comes with continuing updates as major events unfold in the coming 12 months. To get started, click here now.
Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter, holds no position in any company mentioned. Click here to see her holdings and a short bio. The Motley Fool owns shares of Northrop Grumman. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.