Dividend investing is a tried-and-true strategy for generating strong, steady returns in economies both good and bad. But as corporate America's slew of dividend cuts and suspensions over the past few years has demonstrated, it's not enough simply to buy a high yield. You also need to make sure those payouts are sustainable.
First and foremost, dividend investors like a large forward yield. But if a yield gets too high, it may reflect investors' doubts about the payout's sustainability. If investors had confidence in the stock, they'd be buying it, driving up the share price and shrinking the yield.
General Electric yields 3.8%, significantly higher than the S&P's 1.9%
2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company paid out in dividends last year to the earnings it generated. A ratio that's too high -- say, greater than 80% of earnings -- indicates that the company may be stretching to make payouts it can't afford, even when its dividend yield doesn't seem particularly high.
General Electric's payout ratio is a modest 41%.
3. Balance sheet
The best dividend payers have the financial fortitude to fund growth and respond to whatever the economy and competitors throw at them. The interest coverage ratio indicates whether a company is having trouble meeting its interest payments -- any ratio less than 5 is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.
General Electric's debt-to-equity ratio is 362%, largely because of its extensive financing division. This may seem like a lot (and it is), but it'\'s not as bad as it seems, because that debt is cheap: GE's operating earnings cover its interest payments 11 times over.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Let's examine how General Electric stacks up next to its peers:
5-Year Earnings-Per-Share Growth
5-Year Dividend Growth
|3M (NYS: MMM)||6%||4%|
|Honeywell (NYS: HON)||7%||8%|
|Danaher (NYS: DHR)||14%||15%|
Source: Capital IQ, a division of Standard & Poor's.
General Electric's been the laggard of industrial conglomerates, largely because of its overexposure to finance leading into the financial crisis.
The Foolish bottom line
General Electric made the right call by reducing its dividend in 2009 to what appears to be a fairly healthy, stable, and rising level today. Leverage could become an issue again, though -- should we experience another financial crisis, there's a strong chance the dividend could be affected.
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At the time this article was published Ilan Moscovitz doesn't own shares of any companies mentioned. You can follow him on Twitter, where he goes by @TMFDada. Motley Fool newsletter services have recommended buying shares of 3M. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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