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

Company

Recent Yield

5-Year Avg. Annual Div. Growth Rate

Payout Ratio

My Watchlist

Wal-Mart (NYSE: WMT) 2.8% 14.9% 27% Add
Target (NYSE: TGT) 2.0% 17.3% 21% Add
Fred's (Nasdaq: FRED) 1.6% 10.5% 22% Add
Family Dollar (NYSE: FDO) 1.4% 9.1% 22% Add
Costco (Nasdaq: COST) 1.2% 20.6% 26% Add

Data: Motley Fool CAPS.

If you focus on dividend yield alone, you would rightly notice Wal-Mart, but you might miss Target. On the dividend growth front, Costco stands out; its tiny dividend is growing rapidly, with plenty of room for future expansion.

You might also notice that a few names are missing from this list. Kmart's parent, Sears Holding (Nasdaq: SHLD), has been struggling in recent years, and it doesn't pay a dividend. (Its recent deal to sell a Kardashian line of clothing has some scratching their heads.) Others in the space are still small, spending their excess cash on growth. Tuesday Morning (Nasdaq: TUES) is one example, with just $17 million in cash, and $277 million tied up in inventory. 

Just right
As I see it, Wal-Mart and Target give you the best combination of dividend traits. They sport yields between 2% and 3%, strong dividend growth rates, and low payout ratios. Both offer solid income now and a good chance of significant 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 of great dividend-paying stocks, read about 13 High-Yielding Stocks to Buy Today.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Longtime Fool contributor Selena Maranjian owns shares of Costco and Wal-Mart, as does the Motley Fool. Costco and Wal-Mart are Motley Fool Inside Value recommendations. Costco is a Motley Fool Stock Advisor choice. Motley Fool Options has recommended a diagonal call position on Wal-Mart, which is also a Motley Fool Global Gains recommendation.  Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.