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 Veolia (NYS: VE) 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 Veolia 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.
Even taking into account its proposed dividend cut, Veolia would still yield a massive 7.5%, considerably 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.
Veolia has a moderate payout ratio of 76%. When you compare its proposed lower dividend for 2012 with analyst earnings expectations, that ratio comes out to approximately the same level.
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.
Let's examine how Veolia stacks up next to its peers:
Source: S&P Capital IQ.
Veolia has a fairly high debt burden, but that's not all that unusual among its industry, as we can see from looking at its peers. That's because water management and waste disposal are generally stable, capital-intensive businesses, meaning these companies have the ability and the need to carry a fair bit of debt.
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, Veolia's earnings have cratered, largely due to the ongoing European economic crisis (Veolia does the vast majority of its business in Europe, particularly France), while its U.S. peers have been coping with the downturn relatively well:
Source: S&P Capital IQ.
The Foolish bottom line
Veolia's struggling to handle the ongoing European economic crisis. With such a massive yield, it could very well turn out to be a dividend dynamo, albeit a higher-risk one. If you're looking for other great, perhaps safer, 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 Waste Management and Clean Harbors.Motley Fool newsletter serviceshave recommended buying shares of Waste Management, Veolia Environnement, and Republic Services.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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