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 ConocoPhillips (NYS: COP) 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 ConocoPhillips 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.
ConocoPhillips yields 3.8%, a bit better 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.
ConocoPhillips has a modest payout ratio of 2%.
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.
Because capital structures are largely industry-dependent, let's see how ConocoPhillips stacks up next to its peers:
ExxonMobil (NYS: XOM)
Chevron (NYS: CVX)
BP (NYS: BP)
Source: S&P Capital IQ.
Oil exploration and production may be a capital-intensive business, but it's also a profitable one -- each of these oil majors seems to have a manageable debt burden.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
5-Year Earnings-Per-Share Growth
5-Year Dividend Growth
Source: S&P Capital IQ.
Across the industry, earnings obviously collapsed along with the price of oil during the height of the 2008-2009 financial crisis. But energy prices -- and earnings -- have made a quick turnaround, to the point where Exxon, Chevron, and BP are now earnings more than they were pre-crisis.
The Foolish bottom line
Given its large yield, ConocoPhillips could very well be a dividend dynamo. While its payout ratio is low enough that it should be able to continue raising its dividend somewhat -- even in the absence of much earnings growth -- dividend investors will certainly want to keep an eye on whether ConocoPhillips is able to do a better job growing its earnings in the coming years. If you're looking for some more certain 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.
At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned.You can follow him on Twitter, where he goes by@TMFDada.Motley Fool newsletter serviceshave recommended buying shares of Chevron. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't 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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