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.
World Wrestling Entertainment yields 5.3%, considerably higher than the S&P 500's 2%.
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.
World Wrestling Entertainment has a massive payout ratio of 193%, though it improves slightly to 136% on a free cash flow basis. The company hasn't had a sub-100% net income payout ratio since 2005, but it has generated free cash flow in excess of its dividends from time to time.
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.
World Wrestling Entertainment carries a negligible amount of debt.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Over the past five years, World Wrestling Entertainment's earnings per share have declined at an average annual rate of 13%, and it cut its quarterly dividend from $0.36 to $0.12 last June.
The Foolish bottom line
So is World Wrestling Entertainment a dividend blowup? Although the recent dividend cut certainly helps, the company will still need to improve its earnings in the coming years (as analysts expect) in order to afford the new rate. However, if you're looking for some solid dividend stocks, I suggest you check out "Secure Your Future With 11 Rock-Solid Dividend Stocks," a special report from The Motley Fool about some serious dividend dynamos. I invite you to grab a free copy to discover everything you need to know about these 11 generous dividend payers -- simply click here.
At the time this article was published Ilan Moscovitz doesn't own shares of any company mentioned. 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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