Plum Creek Timber: Dividend Dynamo or Blowup?

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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.

Let's examine how Plum Creek Timber (NYS: PCL) stacks up. In this series, we consider four critical factors investors should examine in every dividend stock. We'll then tie it all together to look at whether Plum Creek is a dividend dynamo or a disaster in the making.

1. Yield
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.

Plum Creek yields 4.3%, considerably higher than the S&P 500's 2.1%.

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.

The payout ratio is somewhat less important when evaluating real estate investment trusts like Plum Creek, because they are required to pay out at least 90% of their earnings in the form of dividends in order to avoid paying corporate income taxes.

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 five is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.

Plum Creek has a debt-to-equity ratio of 213% and an interest coverage rate of two times. This isn't ideal, but it's not particularly unusual for the timber industry, which is a fairly capital-intensive business.

4. Growth
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.

This may sound paradoxical, but timber is a stable yet cyclical industry. Over the past five years, Plum Creek's earnings per share have fallen at an average annual rate of 7%, while its dividend has grown at a 1% rate.

The Foolish bottom line
I wouldn't call it a traditional dividend dynamo, but Plum Creek has a more-or-less reasonable dividend bill of health. It has a high yield and manageable debt. Dividend investors will want to keep an eye on the health of the timber business and Plum Creek's earnings to ensure that it's able to continue growing its dividend in the future. If you're looking for some great dividend stocks, 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 the 11 generous dividend payers - simply click here.

At the time this article was published Ilan Moscovitzdoesn't own shares of any company mentioned.You can follow him on Twitter@TMFDada. The Motley Fool owns shares of Plum Creek Timber. The Fool owns shares of and has created a covered strangle position on Plum Creek Timber. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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