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 Ford (NYS: F) 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 Ford 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.
Ford yields 1.5%, a bit lower 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.
Ford has a modest payout ratio of 17%.
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 times 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 Ford stacks up next to its peers:
General Motors (NYS: GM)
Toyota (NYS: TM)
Honda Motor (NYS: HMC)
Source: S&P Capital IQ.
Toyota, Honda, and especially Ford, carry quite a bit of debt relative to their equity, whereas GM's bankruptcy extinguished most of its debt. Still, at current levels of operating income, none of these car makers is having trouble making their interest payments. Given its levels of free cash flow, Ford's apparently high debt-to-equity ratio is much less of a concern than it may appear.
A large dividend is nice; a large, growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
The economic downturn was brutal for the auto industry, with General Motors and Chrysler declaring bankruptcy. Ford, GM, and Toyota posted big losses during the financial crisis before returning to profitability in 2010. With an aging U.S. auto fleet, many analysts are predicting strong sales over the coming years.
The Foolish bottom line
Although a few years of dividend growth under its belt will be necessary before we could consider Ford a dividend dynamo, with a modest payout ratio and manageable debt, Ford exhibits a clean dividend bill of health. If you're looking for some great dividend stocks, 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 the 11 generous dividend-payers -- simply click here.
At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned.The Motley Fool owns shares of Ford Motor.Motley Fool newsletter serviceshave recommended buying shares of General Motors and Ford Motor and creating a synthetic long position in Ford Motor. 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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