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 Best Buy (NYS: BBY) 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 Best Buy 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.
Best Buy yields 2.6%, a bit higher than the S&P 500's 2.1%.
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.
Best Buy has a modest payout ratio of only 21%.
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 times is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.
Best Buy has a debt-to-equity ratio of 36% and an interest coverage rate of 17 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.
Over the past five years, Best Buy has grown its earnings per share at an average annual rate of 3%, while its dividend has grown at an 11% rate.
The Foolish bottom line
Best Buy's yield may be a bit too low to consider it a "dividend dynamo" just yet, but the company certainly exhibits a clean dividend bill of health, and its dividend growth is impressive. It has a moderate yield, a reasonable payout ratio, and manageable debt, with growth to boot. While dividend investors will obviously still want to keep an eye on looming competitive threats like Amazon.com, Best Buy's payout ratio is low enough that it should be capable of growing its dividend at a faster rate than earnings for the foreseeable future.
If you're looking for other great dividend stocks, I suggest you check out "Secure Your Future With 11 Rock-Solid Dividend Stocks," a special report from the Motley Fool about some serious dividend dynamos. I invite you to grab a free copy to discover everything you need to know about these 11 generous dividend-payers -- simply click here.
At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned.You can follow him on Twitter@TMFDada. The Motley Fool owns shares of Best Buy and Amazon.com.Motley Fool newsletter serviceshave recommended buying shares of Amazon.com.Motley Fool newsletter serviceshave recommended writing covered calls in Best Buy. 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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