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 Lowe's (NYS: LOW) 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 Lowe's 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.
Lowe's yields 2.1%, about in-line with the S&P 500.
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.
Lowe's has a modest payout ratio of 35%.
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 Lowe's stacks up next to its peers:
Source: S&P Capital IQ.
None of these home improvement stores carry particularly high levels of debt relative to their equity, while Lumber Liquidators is debt-free. Sears' interest coverage troubles are the result of its plunging operating income.
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. *3-Year Growth.
Although Lowe's sales have held up fairly well over the economic downturn, its earnings have been under pressure. Home Depot faced greater difficulties but its business rebounded more dramatically. Lumber Liquidators, a low-cost provider of hardwood flooring, has picked up some strength during the downturn, while Sears has yet to return to profitability.
The Foolish bottom line
While Lowe's has neither the yield nor the recent growth of a dividend dynamo, it nonetheless exhibits a fairly strong dividend bill of health based on its low payout ratio and manageable debt. 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 thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned.The Motley Fool owns shares of Lumber Liquidators Holdings.Motley Fool newsletter serviceshave recommended buying shares of The Home Depot, Lowe's Companies, and Lumber Liquidators Holdings.Motley Fool newsletter serviceshave recommended writing covered calls in Lowe's Companies. 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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