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.
Spectra yields a 4.3%, considerably 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.
Spectra's payout ratio is 58%.
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.
Let's examine how Spectra stacks up next to its peers:
El Paso (NYS: EP)
Williams Companies (NYS: WMB)
Southern Union (NYS: SUG)
Source: Capital IQ, a division of Standard & Poor's.
Spectra carries a significant amount of debt, like many of its natural gas distribution peers, which tend to be willing and able to employ leverage due to their capital-intensive nature and earnings reliability.
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 three years, Spectra's earnings per share shrunk at a 2% annual rate, while its dividend increased at a 4% rate.
The Foolish bottom line
Spectra exhibits a fairly clean dividend bill of health. It has a high yield and a reasonable free cash flow payout ratio. The company does carry a significant amount of debt, so dividend investors will want to keep an eye on earnings to ensure that they remain consistent.
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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 El Paso.Motley Fool newsletter serviceshave recommended buying shares of Spectra Energy. 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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