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

Company

Recent Yield

5-Year Avg. Annual Div. Growth Rate

Payout Ratio

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Einstein Noah Restaurant Group (Nasdaq: BAGL) 3.9% New dividend 37% Add
Darden Restaurants (NYSE: DRI) 3.8% 25.7% 41% Add
P.F. Chang's China Bistro 3.6% New dividend 49% Add
Bob Evans Farms 3.3% 9.4% 41% Add
McDonald's (NYSE: MCD) 3.2% 22.4% 48% Add
Brinker International 2.9% 20.3% 37% Add
CEC Entertainment 2.7% New dividend 14% Add
Cracker Barrel Old Country Store 2.5% 12.2% 24% Add
Texas Roadhouse (Nasdaq: TXRH) 2.4% New dividend 20% Add
Yum! Brands (NYSE: YUM) 2.2% 28.1% 39% Add
Wendy's 1.7% (38.9%) 750% Add
Tim Hortons 1.4% 22.9% 16% Add

Data: Motley Fool CAPS.

If you focus on dividend yield alone, you might end up with companies that have low dividend growth rates or steep payout ratios. That isn't the case here, though many on the list don't yet have much of a track record of dividend hikes, so it's not clear how rapidly they might increase their payouts.

Instead, let's focus on the dividend growth rate first, where Yum! Brands leads the way. Its growth rate is so steep, though, that it may be hard to maintain for long -- though its modest payout ratio doesn't make that an immediate concern.

You may notice, too, that some notable players in the industry, such as Krispy Kreme Doughnuts (NYSE: KKD) and Dunkin' Brands Group (Nasdaq: DNKN), aren't on the list. Dunkin' is a fast-growing company that may prefer to plow any excess cash into further growth rather than pay it out to shareholders. But Krispy Kreme is on the down side of its growth curve after much better times in the past.

Just right
As I see it, among the companies above, Einstein Noah Restaurant Group and Darden Restaurants offer the best combination of dividend traits, sporting some solid income now and a chance of strong dividend growth in the future. Give McDonald's and Yum! Brands serious consideration, too, though, as they're huge, have impressive track records, and have been strong dividend growers, to boot.

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.

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

Longtime Fool contributor Selena Maranjian owns shares of McDonald's, but she holds no other position in any company mentioned. Click here to see her holdings and a short bio. The Motley Fool owns shares of Yum! Brands. Motley Fool newsletter services have recommended buying shares of Tim Hortons, McDonald's, and Yum! Brands. 

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