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.
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.
Pfizer yields 4%, considerably higher than the S&P's 1.9%.
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.
Pfizer has a moderate payout ratio of 62%, though that figure falls quite a bit to 34% on a free cash flow basis.
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.
Pfizer has a moderate debt-to-equity ratio of 47% and an interest coverage rate of 12 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.
All told, over the past five years, Pfizer's earnings plunged have sunk at an average annual rate of 6%, while its quarterly dividend has gradually risen to $0.22 after being cut in half from $0.32 to help finance its 2009 acquisition of Wyeth.
The Foolish bottom line
So is Pfizer a dividend dynamo? Perhaps. It has a high yield, a moderate payout ratio, and manageable debt. However, dividend investors will still want to keep an eye on how well Pfizer is able to manage its pipeline issues as more of its brand-name drugs continue to go off patent to ensure that the company is able to grow its earnings over time. If you're looking for some solid dividend stocks, I also suggest you check out "Secure Your Future With 9 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.
At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned.You can follow him on Twitter, where he goes by@TMFDada. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't 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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