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 International Paper (NYS: IP) 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 International Paper is a dividend dynamo or a disaster in the making.
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.
International Paper yields 3.6%, 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.
International Paper's payout ratio is a modest 26%.
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 5 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 International Paper stacks up next to its peers:
Source: S&P Capital IQ.
International Paper appears considerably more leveraged than its peers, though it historically hasn't had problems earning enough to meet its interest obligations.
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 International Paper has performed over the past few years:
Source: S&P Capital IQ.
The Foolish bottom line
International Paper exhibits a clean dividend bill of health. It has a moderate yield, a modest payout ratio, and strong earnings growth. Given these factors, the company could probably afford to boost its payouts or continue on its path of debt reduction. To stay up to speed on International Paper'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 thisarticle was published Ilan Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter @TMFDada. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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