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 diversified utilities 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' 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 intodiversified utilities
Dividend investors typically focus first on yield. Avista (NYS: AVA) and Public Service Enterprise Group (NYS: PEG) are among the highest-yielding stocks in diversified utilities, offering 4.3% each. But they're far from alike, despite their yields. Avista's yield has been growing at an average annual clip of nearly 15% over the past five years, while Public Service Enterprise's dividend growth has averaged just 3.8%. Avista delivers electricity and gas to nearly half a million customers, producing its energy via a mix of hydro, natural gas, coal and biomass generation. Public Service, focused on the Northeast, has above-average profit margins going for it.
Meanwhile, Consolidated Edison (NYS: ED) is appealing with its 3.8% yield, but its dividend's five-year growth rate has averaged less than 1%. The company has recently been embroiled in a labor dispute, and has locked out some workers.
You may instead choose to focus on the dividend growth rate first, where CMS Energy leads the way, nearly quintupling its payout over the past five years. That growth rate is so steep, though, that it may be hard to maintain for long.
The lesson here is to not focus on any one metric. Look at a bunch to see which companies truly stand out.
As I see it, Avista offers the best combination of dividend traits, sporting some solid income now and a good chance of strong dividend growth in the future. But many stocks in this industry are appealing.
You might also want to check out Exelon (NYS: EXC) and PG&E (NYS: PCG) , for example. Exelon is the nation's largest nuclear power generator, but it's also diversified into other energy types -- financing solar farms, for example. Like various peers, it's poised to benefit whenever the price of natural gas starts going up again, and it also carries less debt than many peers. PG&E is the nation's largest investor-owned hydroelectric utility, which is attractive due to the low cost of the energy. The downside, though, is that the hydroelectric growth rate is tempered by the finite availability of land and water.
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.
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The article The Most Promising Dividends in Diversified Utilities originally appeared on Fool.com.
Longtime Fool contributorSelena Maranjian, whom you canfollow on Twitter, holds no position in any company mentioned.Click hereto see her holdings and a short bio.Motley Fool newsletter serviceshave recommended buying shares of and writing a covered straddle position on Exelon. The Motley Fool has adisclosure policy.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.