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 Lender Processing Services (NYS: LPS) 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 LPS 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.
LPS yields 1.8%, slightly below the S&P 500's 2%.
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.
LPS has a modest payout ratio of 36%.
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.
LPS has a fairly substantial debt-to-equity ratio of 235% and an interest coverage rate of five times.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Over the past four years, LPS' earnings per share have fallen 57%. The company has paid a steady $0.10 quarterly dividend since late 2008. In the industry as a whole, sloppy and allegedly fraudulent mortgage servicing processes over the past couple of years have led to fewer foreclosures, which has been a factor.
Since it's deeply involved in the back end of mortgage servicing, LPS also has its fair share of legal issues to sort out. It's been accused of acting as a sort of general contractor for "robo-signing" law firms and of collecting illegal fees, and has been the subject of shareholder class-action lawsuits. In the several years since the issue became public, Missouri has charged one of LPS' shuttered subsidiaries with forgery.
The Foolish bottom line
So is LPS a dividend dynamo or a blowup? With a moderate yield and a modest payout, LPS may look like a safe dividend stock. But with the company's legal troubles, in addition to its leverage and volatile earnings, it's just not worth the risk.
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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.