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 Waste Management (NYS: WM) 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 Waste Management 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.
Waste Management yields 4.2%, quite 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.
Waste Management has a moderate payout ratio of 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 five is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.
Waste Management has a moderate debt-to-equity ratio of 154% and an interest coverage rate of four times. That may seem like a significant amount of debt, but it's not unusual for utilities, which tend to operate stable, capital-intensive businesses.
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, Waste Management's earnings per share have shrunk at an average annual rate of 1%, while its dividend has grown at a 9% rate.
The Foolish bottom line
Waste Management could very well be dividend dynamo. It has a fairly high yield, a moderate payout ratio, and reasonable debt. While earnings are beginning to recover after the worst of the economic downturn and are expected to increase at an 8% rate over the next few years, investors will still want to keep an eye on earnings to make sure that growth materializes. If you're looking for some other great dividend stocks, 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 the 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 Waste Management.Motley Fool newsletter serviceshave recommended buying shares of Waste Management.Motley Fool newsletter serviceshave recommended creating a write covered strangle position in Waste Management. 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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