United Parcel Service: Dividend Dynamo or the Next Blowup?

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 United Parcel Service (NYS: UPS) 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 UPS is a dividend dynamo or a disaster in the making.

1. Yield
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.

UPS yields 2.7%, 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.

UPS' payout ratio is a moderate 49%.

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 DuPont stacks up next to its peers:

Debt-to-Equity Ratio
Interest Coverage
United Parcel Service158%17 times
FedEx11%46 times
Union Pacific48%10 times
Norfolk Southern76%7 times

Source: S&P Capital IQ.

UPS' debt-to-equity ratio is 146%. That's considerably higher than that of its peers, but the interest it owes is covered a full 17 times over.

4. Growth
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
Union Pacific19%21%
Norfolk Southern8%21%

Source: S&P Capital IQ.

UPS and FedEx took a hit during the economic downturn of the past few years, though both have seen earnings rebound dramatically. Meanwhile, Warren Buffett's thesis seems to be playing out: Railroads, which don't have to deal with traffic congestion or stingy transportation infrastructure spending, should enjoy the benefits of a superior cost structure.

The Foolish bottom line
UPS exhibits a fairly clean dividend bill of health. It has a reasonable payout ratio and manageable debt. Given its moderate yield, however, UPS investors looking for a dividend dynamo will want to keep an eye on the company's earnings growth to ensure that it continues boosting those payouts. If you're looking for some 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 this article was published Ilan Moscovitzdoesn't own shares of any company mentioned. You can follow him on Twitter@TMFDada. The Motley Fool owns shares of United Parcel Service and FedEx.Motley Fool newsletter serviceshave recommended buying shares of FedEx.  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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