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.
Energy Transfer Partners yields 8.3%, considerably higher than the S&P's 1.9%. Normally this might be cause for concern, but it's normal for Real Estate Investment Trusts -- or REITs -- like Energy Transfer Partners to pay high dividend yields.
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 REITs because they are required to pay out a high percentage of their earnings in the form of dividends in order to avoid paying corporate income taxes. The company's distributable cash payout ratio, a related industry metric, stands at 71%.
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 debt-to-equity ratio is a good measure of a company's total debt burden. We can also look at interest payments as a percentage of interest revenue for a quick way to gauge how comfortably these REITs can afford to make their interest payments.
Let's examine how Energy Transfer Partners stacks up next to its peers:
Interest Coverage Ratio
Energy Transfer Partners
Kinder Morgan Energy Partners (NYS: KMP)
ONEOK Partners (NYS: OKS)
Kinder Morgan (NYS: KMI)
Source: Capital IQ, a division of Standard & Poor's.
Pipelines are a fairly capital-intensive but reliable industry, which explains why these companies are willing and able to carry fairly significant debt burdens.
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 five years, Energy Transfer Partners' earnings per share have declined at an annual rate of 13%. Overall earnings actually increased, albeit slower than the share count. Its dividend per share has increased at a 7% rate.
The Foolish bottom line
Energy Transfer Partners has an excellent dividend yield, even for its peer group. Like other pipelines, the company carries a fairly significant debt burden, so earnings reliability is important. Dividend investors looking for dividend growth will want to keep an eye on the company's earnings-per-share growth to ensure that it's able to continue raising those big payouts.
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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.Motley Fool newsletter serviceshave recommended buying shares of ONEOK Partners. 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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