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.
Nordic American Tankers yields 6.5%, substantially 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.
Nordic American Tankers doesn't have a payout ratio because it didn't generate earnings over the past 12 months. In the past, the company's payout ratio has generally exceeded 100% by a substantial margin, as the company's dividend policy is to pay out dividends "substantially equal to ... net operating cash flow."
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.
Nordic American Tankers has a debt-to-equity ratio of 9%. (It doesn't have an interest coverage ratio because it didn't generate operating income over the past 12 months).
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 Nordic American Tankers stacks up next to its peers:
5-Year Earnings-per-Share Growth
5-Year Dividend Growth
Nordic American Tankers
Frontline (NYS: FRO)
Ship Finance International (NYS: SFL)
Teekay Tankers (NYS: TNK)
Source: Capital IQ, a division of Standard & Poor's. *Negative earnings.
Like many of its peers, Nordic American Tankers has struggled to maintain its earnings and dividend during the economic downturn.
The Foolish bottom line
Nordic American Tankers has a fairly aggressive dividend policy that will often result in abnormally high payout ratios. The company can largely account for it by issuing new shares, but dividend investors should be aware that dilution is the trade-off.
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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. 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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