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.
Veolia yields a whopping 11.4%, 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.
Veolia's payout ratio is 186%, but its reported earnings over the past year were depressed by an asset writedown. On a free cash flow basis, its payout ratio was a much lower 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.
Let's examine how Veolia stacks up next to its peers:
Waste Management (NYS: WM)
Clean Harbors (NYS: CLH)
Republic Services (NYS: RSG)
Source: Capital IQ, a division of Standard & Poor's.
Veolia carries a fairly considerable amount of debt, even for the waste and recycling industry, which tends to employ a fair bit of leverage because of its reliability and capital-intensive nature.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Excluding the effects of the writedowns, earnings per shares increased at a 2% annual rate over the past five years, while the dividend increased at a 7% rate.
The Foolish bottom line
Veolia 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 Waste Management, Clean Harbors, and Veolia Environnement.Motley Fool newsletter serviceshave recommended buying shares of Republic Services and Waste Management.Motley Fool newsletter serviceshave recommended creating a covered strangle position in Waste Management. 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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