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.
GE yields 4%, considerably higher than the S&P'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.
GE has a payout ratio of 41%.
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.
For an industrial conglomerate, GE has a huge debt-to-equity ratio: 368%. But that's largely because of the company's enormous financial division, GE Capital, which by itself would probably qualify as a too-big-to-fail financial institution. Its interest coverage is 14 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.
Let's examine how GE stacks up next to its peers:
3M (NYS: MMM)
Honeywell (NYS: HON)
Rockwell (NYS: ROK)
Source: S&P Capital IQ.
GE was more exposed to the financial crisis than its conglomerate peers were because of its financial segment.
The Foolish bottom line
General Electric made the right call by reducing its dividend in 2009 to what appears to be a healthy and rising level today. Leverage remains a bigger issue than for its peers, though, -- should we experience another "once-in-a-century" financial crisis, there's a strong chance the dividend could be affected again. But aside from that, GE's dividend looks on the mend. To stay up-to-speed on GE's progress, 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.Motley Fool newsletter serviceshave recommended buying shares of 3M.Motley Fool newsletter serviceshave recommended creating a diagonal call position in 3M. 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.
Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.