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 DuPont (NYS: DD) 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 DuPont 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.
DuPont yields 3.2%, 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.
DuPont has a comfortable payout ratio of 44%.
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.
Let's examine how DuPont stacks up next to its peers:
Source: S&P Capital IQ.
Each of these stocks has a high debt-to-equity ratio, but that's not all that unusual in the capital-intensive chemicals industry. DuPont and Eastman are earning more than enough to make their interest payments comfortably.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Source: S&P Capital IQ.
The economic downturn has hit Dow and Huntsman pretty hard over the past several years because of lower demand for chemicals, while DuPont and Eastman Chemical have fared much better.
The Foolish bottom line
DuPont exhibits a fairly strong dividend bill of health. It has a nice yield, a moderate payout ratio, and a manageable debt burden. While its payout ratio is low enough that the company should be able to continue increasing its payouts somewhat, dividend investors will still want to keep an eye on earnings growth. If you're looking for some 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 Moscovitz doesn't own shares of any company mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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