Because of its highly cyclical business, Minnesota- based Graco (NYSE: GGG) isn’t standard fare for conservative investors. Graco makes systems that dispense fluids (paints, coatings, resins, lubricants, etc.) in industrial applications and construction, so its earnings—and share price—tend to rise and fall in sync with the business cycle.

But unlike many other cyclical companies, Graco’s management is both conservative and forward-thinking, a combination that allows the company to pay a rising dividend—its shares yield around 2 percent at time of writing—while also participating in global growth markets.

On the conservative side, Graco has for a long time paid out about 30 percent of its earnings to investors and has had a robust share repurchase program. The company has thus maximized shareholder value without taking on undue risk.

This is possible because Graco’s business generates significant cash flow: some $100 million annually during the past five years (which included a cyclical low in 2009), with 15 percent to 20 percent of this translating into free cash flow (after all expenses, dividends, and investments are paid). Graco’s dividend has risen in each of the past seven years, including a 7 percent increase in December 2011, while its dividend payout ratio remains a manageable 45 percent.

Graco’s favorable cash flow situation is likely to continue, since the company strives to be a low-cost operator. Gross margins consistently run above 50 percent, and operating margins rarely come in much below 20 percent on an annual basis.

In terms of innovation, Graco also excels. Spending on research and development has shot up more than 75 percent during the past five years, far outpacing all of its competitors. As a result, Graco typically launches three to five new products annually, often in specialized markets where it has few or no competitors. Each year, about a third of Graco’s sales are due to new product releases, such as the recently introduced cordless paint sprayers, and the company is also constantly updating its older product lines.

In fact, R&D is the main driver behind Graco’s impressive margins and the reason why the stock has outperformed both the S&P 500 and its sector on a short- and long-term basis.

Graco has also expanded rapidly into a number of key emerging markets, such as Asia and Latin America. As industrial processes in these regions continue to become more sophisticated, demand for advanced fluid-handling and finishing equipment has risen dramatically. Graco should also benefit from a rebound in these regions’ construction sectors, through rising demand for spray paint and insulation applications.

A summer drop in Graco’s stock price affords what we consider to be a buying opportunity (down about 20 percent from its 52-week high). Even though revenue rose 14 percent in the second quarter of 2012, earnings were 8 cents a share less than expected. However, we think this shortfall was mainly due to expenses related to the purchase of the finishing business of Illinois Tool Works (NYSE: ITW). Excluding these one-time costs, earnings would have been in line with expectations.

Graco shares might be a bit aggressive for some conservative investors, as their price volatility is about 60 percent higher than that of the S&P 500. But for those willing to buy and hold, we consider Graco an excellent growth-and-income stock, with strong upside potential tied to the global economy and the prospect of a steadily increasing dividend.