American Electric Power: Dividend Dynamo or the Next Blowup?

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.

Let's examine how American Electric Power (NYS: AEP) stacks up. In this series, we consider four critical factors investors should examine in every dividend stock. We'll then tie it all together to look at whether American Electric is a dividend dynamo or a disaster in the making.

1. Yield
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.

American Electric yields 4.5%, quite a bit higher than the S&P's 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.

American Electric's payout ratio is 49%.

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 -- a ratio less than five can be a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.

Let's examine how American Electric stacks up next to its peers:

American Electric121%3 times
Southern Co. (NYS: SO) 111%4 times
Consolidated Edison (NYS: ED) 92%4 times
Dominion Resources (NYS: D) 170%5 times

Source: S&P Capital IQ.

Electric generation is a capital-intensive and stable business. Hence, like many of its peers, American Electric has both the need and the means to carry a fairly significant level of debt.
4. Growth
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.

Here's how American Electric has performed over the last half-decade:

American Electric7%4%
Southern Co.3%4%
Consolidated Edison6%1%
Dominion Resources3%7%

Source: S&P Capital IQ.

The Foolish bottom line
American Electric exhibits a clean dividend bill of health. It has a fairly high yield, a moderate payout ratio, and strong growth. The company's debt burden is one area dividend investors may want to pay some attention to, but given the company's earnings stability, it's well within reasonable bounds. To stay up to speed on American Electric'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 by clicking here.

At the time this article 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 Southern and Dominion Resources. 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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