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.
Pfizer yields 4.0%, considerably higher than the S&P's 1.8%.
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.
Pfizer's payout ratio is 74%. On a free cash flow basis, that figure falls to 30%.
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.
Pfizer's debt-to-equity ratio is 46%. It's interest coverage rate is 10 times.
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 Pfizer stacks up next to its peers.
5-Year Earnings-per-Share Growth
5-Year Dividend Growth
Johnson & Johnson (NYS: JNJ)
Merck (NYS: MRK)
Abbott Laboratories (NYS: ABT)
Source: Capital IQ, a division of Standard & Poor's.
The Foolish bottom line
Pfizer exhibits a fairly reasonable dividend bill of health. It has a moderately high yield, a modest free cash flow payout ratio, and moderate debt. Dividend investors will want to keep an eye on the company's earnings growth, which is the biggest potential cause for conern, particularly with several of the company's blockbuster drugs coming off-patent in the near future.
At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any companies mentioned. You can follow him on Twitter at@TMFDada. The Motley Fool owns shares of Abbott Laboratories and Johnson & Johnson.Motley Fool newsletter serviceshave recommended buying shares of Abbott Laboratories, Johnson & Johnson, and Pfizer and creating a diagonal call position in Johnson & Johnson. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't 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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