The Most Promising Dividends in Coal

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 coal 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:

  • 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% 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 coal
Among coal stocks, Oxford Resource Partners and Natural Resource Partners are among the highest-yielding stocks, offering 11.6% and 7.9%, respectively. But they're not necessarily your best bets. Oxford just debuted on the market via IPO in 2010, and it's not profitable at the moment. Natural Resource, meanwhile, sports a scary payout ratio, although the fact that it's a master limited partnership that's required to distribute income explains the payout ratio in part. Penn Virginia Resource Partners (NYS: PVR) , with a 7.7% yield, also sports a steep payout ratio, along with slowing earnings growth. Its top line has been growing, though, offering some hope that it can turn things around.

Let's next turn to the dividend growth rate, where Walter Energy (NYS: WLT) leads the way, with a five-year average annual dividend growth rate of 27.4%. That growth rate is so steep in part because its yield is very low, at less than 1%. Even at a fast growth rate, it'll take a while to reach an attractive level. In the meantime, it's appealing to some investors for its positive cash flow generation and because some think it might get bought out.

Some coal companies, such as Patriot Coal (NYS: PCX) and James River Coal (NAS: JRCC) , don't pay dividends at all. That's because smaller or fast-growing companies often prefer to plow any excess cash into further growth rather than pay it out to shareholders. Patriot Coal is conserving cash after having been plagued with production problems lately, while James River spent cash to acquire greater metallurgical coal production capability. Both companies can benefit from strong global demand for coal and for met coal, used in steel production.

Just right
As I see it, Alliance Resource Partners and Yanzhou Coal Mining (NYS: YZC) offer the best combination of dividend traits, sporting some solid income now and a good chance of strong dividend growth in the future. Yanzhou, with a recent yield of 3.8% and a five-year dividend growth rate of 12%, has benefited from rising coal prices in China and has boosted its production capacity. Alliance Resource, yielding 5.1% and growing its dividend at 13% annually, boasts some long-term contracts that can protect it from market volatility.

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 someAll-Star dividend-paying stocks? Look no further.

At the time thisarticle was published

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.