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.
AT&T yields a whopping 5.8%, considerably higher 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.
AT&T has a payout ratio of 86%. On a free cash flow basis, however, that figure falls a bit down to 65%.
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.
AT&T has a debt-to-equity ratio of 63% and interest coverage of 6, which are both about in line with its industry.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Let's examine how AT&T stacks up next to its peers.
5-Year Earnings-per-Share Growth
5-Year Dividends-per-Share Growth
Verizon (NYS: VZ)
MetroPCS (NYS: PCS)
Sources: S&P Capital IQ. The Foolish bottom lineAT&T exhibits a reasonable dividend bill of health. It has a huge yield and a manageable debt burden. Considering its moderately high payout ratio, dividend investors may want to keep an eye on the company's growth to ensure that it's able to continue increasing those payouts. To stay up to speed on the top news and analysis on AT&T, or 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.
At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned.You can follow him on Twitter, where he goes by@TMFDada. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't 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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