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.
ConocoPhillips yields 3.9%, a bit 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.
ConocoPhillips has a pretty low payout ratio of 30%, though that rises somewhat to a still-reasonably 48% when we consider it on a free cash flow payout basis to take into account current capital expenditure levels.
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.
ConocoPhillips' debt-to-equity ratio is a fairly modest 39%. It has an interest coverage rate of 19 times.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Source: S&P Capital IQ.
The Foolish bottom line
ConocoPhillips exhibits a fairly clean dividend bill of health. While its payout ratio is low enough that it should be able to continue raising its dividend somewhat, even in the absence of much earnings growth, dividend investors will certainly want to keep an eye on whether ConocoPhillips is able to do a better job generating earnings growth. To stay up to speed on ConocoPhillips'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.Motley Fool newsletter serviceshave recommended buying shares of Chevron. 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.
Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.