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 Northrop Grumman (NYS: NOC) 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 Northrop Grumman 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.
Northrop Grumman yields 3.4%, 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.
Northrop Grumman has a modest payout ratio of 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 -- 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 see how Northrop Grumman stacks up next to its competitors:
Boeing (NYS: BA)
General Dynamics (NYS: GD)
Lockheed Martin (NYS: LMT)
Source: S&P Capital IQ.
There may be great variety in each of these company's capital structures, but relative to their profitability, none has burdensome interest payments.
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-Per-Share Growth
Source: S&P Capital IQ.
Defense has obviously enjoyed a boom era in recent years, thanks to multiple wars and large-scale federal spending. While analysts predict earnings to continue growing at a healthy clip for Boeing, GD, and Lockheed, and Northrop's to hold steady, the future of the defense budget isn't entirely certain as the wars wind down and politicians look for budget cuts.
The Foolish bottom line
Despite the tremendous uncertainty over looming defense cuts, Northrop might still be a dividend dynamo. It has a healthy yield and manageable debt. Its payout ratio is low enough that it should be able to sustain and grow its dividend even if earnings do take a bit of a hit. 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.The Motley Fool owns shares of General Dynamics, Northrop Grumman, and Lockheed Martin. 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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