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.
Best Buy yields 2.2%, slightly 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.
Best Buy's payout ratio is a modest 19%.
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.
Best Buy's debt-to-equity ratio is 31%, while its interest coverage rate is 24 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 Best Buy stacks up next to its peers:
5-Year Earnings-per-Share Growth
5-Year Dividend Growth
RadioShack (NYS: RSH)
Amazon.com (NAS: AMZN)
Sears (NAS: SHLD)
Source: Capital IQ, a division of Standard & Poor's. N/A = not applicable due to negative earnings.
The Foolish bottom line
Best Buy exhibits a clean dividend bill of health. It has a modest payout ratio and almost no debt. Dividend investors will want to keep an eye on Best Buy's earnings growth, though the company's low payout ratio could allow its dividend growth to continue outstripping earnings growth .
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At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any companies mentioned. You can follow him on Twitter @TMFDada. The Motley Fool owns shares of RadioShack and Best Buy.Motley Fool newsletter serviceshave recommended buying shares of Best Buy and Amazon.com. 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.Fool has adisclosure policy.
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