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.
Aqua America yields 3.1%, considerably better than the S&P 500's 2.2%.
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.
Aqua America has a moderate payout ratio of 60%.
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 Aqua America stacks up next to its peers:
American Water Works (NYS: AWK)
California Water Service Group (NYS: CWT)
American States Water (NYS: AWR)
Source: S&P Capital IQ.
Aqua America has a fairly high debt-to-equity ratio, but that's not all that unusual among capital-intensive utilities.
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, Aqua America's earnings per share and dividends have grown at an annual rate of 8%.
The Foolish bottom line
Aqua America exhibits a reasonable dividend bill of health. Its strong yield is covered by earnings, and it's done a good job growing over the past several years. Because of its fairly high leverage, dividend investors will want to ensure that the company is able to continue on its impressive track of earnings stability. To stay up to speed on Aqua America's progress, or on any other stock, add it to your stock watchlist. If you don't have one yet, you can create a free, personalized watchlist of your favorite stocks by clicking here.
At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned.You can follow him on Twitter@TMFDada. The Motley Fool owns shares of California Water Service Group.Motley Fool newsletter serviceshave recommended buying shares of Aqua America and California Water Service Group. 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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