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.
Philip Morris yields 3.8%, quite a bit 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.
Philip Morris's payout ratio is a reasonable 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 Philip Morris stacks up next to its peers:
Philip Morris International
Altria Group (NYS: MO)
Reynolds American (NYS: RAI)
Lorillard (NYS: LO)
Source: Capital IQ, a division of Standard & Poor's. * Negative equity.
With a debt-to-equity ratio of 327%, it would appear that Philip Morris is very heavily leveraged. However, that figure doesn't tell the full story, because it can cover interest payments fairly easily with current earnings. Those two observations hold true for much of the tobacco industry. This makes sense -- it's an addictive product with a fairly reliable customer base, so as long as earnings remain stable, high leverage may not be as big a problem as it appears.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Philip Morris' earnings have grown 7% annually over the past three years, a bit higher than its peers', while its dividend has grown at an average 9% rate over the past two years (the longest period for which data is available due to the company's recent spinoff from Altria).
The Foolish bottom line
Overall, Philip Morris exhibits a fairly clean dividend bill of health. The company's yield might be a bit lower than the peer average, but so is its payout ratio -- perhaps because Philip Morris sees more growth opportunities in which to invest. Continued earnings stability will be important to ensure that the company's debt burden remains manageable.
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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 Philip Morris International and Altria Group.Motley Fool newsletter serviceshave recommended buying shares of Philip Morris International. 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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