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 railroad 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 whyyou'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.
Below, I've compiled some of the major dividend-paying players in the railroad industry (and a few smaller outfits), ranked according to their dividend yields:
5-Year Avg. Annual Div. Growth Rate
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Norfolk Southern (NYS: NSC)
CSX (NYS: CSX)
Canadian Pacific Railway (NYS: CP)
Union Pacific (NYS: UNP)
Canadian National Railway (NYS: CNI)
Trinity Industries (NYS: TRN)
Westinghouse Air Brake Technologies
Source: Motley Fool CAPS.
If you focus on dividend yield alone, you might end up with Guangshen Railway, but its negative growth rate means it's not necessarily your best bet. However, note that after a big drop between 2006 and 2007, Guangshen's dividend has been steadily rising.
When it comes to overall dividend growth, Westinghouse Air Brake Technologies leads the way, even though its growth rate stems solely from its recent decision to triple its puny $0.01-per-share payout to $0.03. That currently tiny yield will take a while to reach an attractive level, even at a swift growth rate.
You may also notice that other notable industry players such as RailAmerica (NYS: RA) aren't on the list. That's often because smaller, fast-growing companies often prefer to plow any excess cash into further growth, rather than pay it out to shareholders.
As I see it, among the companies above, Norfolk Southern and CSX offer the best combination of dividend traits. They offer solid income now and a good chance of strong dividend growth in the future. The other companies are also worth a look, since they have strong support in our Motley Fool CAPS community.
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.
At the time thisarticle was published Longtime Fool contributor Selena Maranjian owns shares of Canadian National Railway, 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 RailAmerica. Motley Fool newsletter services have recommended buying shares of Guangshen Railway and Canadian National Railway. 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.
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