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

Company

Recent Yield

5-Year Avg. Annual Div. Growth Rate

Payout Ratio

Add to Watchlist

MDC Holdings (NYSE: MDC) 3.9% 1.7% NM Add
KB Home (NYSE: KBH) 2.1% (26%) NM Add
D.R. Horton 1.3% (23.9%) 83% Add
Lennar (NYSE: LEN) 0.9% (27.1%) 24% Add
Ryland Group 0.7% (23.6%) NM Add

Data: Motley Fool CAPS. NM = Not meaningful due to negative earnings.

If you focus on dividend yield alone, you might end up with MDC Holdings, but it's not necessarily your best bet, with its small dividend growth rate and negative earnings.

If you look for robust dividend growth rates, you won't find them here, as the industry has been struggling mightily in recent years, with the weak real estate market and the recession.

You may also notice that some well-known names in the industry are not in the table because of financial difficulties. PulteGroup (NYSE: PHM) suspended its dividend in 2008, while Standard Pacific (NYSE: SPF) did so in 2007.

Just right
As I see it, MDC Holdings looks the most attractive among the companies above, offering some solid income now, though not much strong dividend growth likely in the near future. You needn't settle for it, though. If you're bullish on building, consider other companies that serve the industry, such as Home Depot (NYSE: HD) and Lowe's (NYSE: LOW). Home Depot's dividend yield is 2.8% and its five-year growth rate approaches 12%. Lowe's sports a yield around 2.4% and a whopping growth rate of 31%. Both companies have positive earnings and reasonable payout ratios.

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 Maranjianowns shares of Home Depot, but she holds no other position in any company mentioned. Click here to see her holdings and a short bio. Motley Fool newsletter services have recommended buying shares of MDC Holdings, Home Depot, and Lowe's; writing covered calls on Lowe's; and shorting Standard Pacific. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.