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 First Niagara Financial (NAS: FNFG) 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 First Niagara 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.
First Niagara yields 3.5%, considerably higher than the S&P 500'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.
First Niagara has a modest payout ratio of 50%.
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 Tier 1 capital ratio is a commonly used leverage metric for banks that compares equity and reserves with total risk-weighted assets. In a nonfinancial crisis, a ratio above 12% is generally considered to be relatively conservative. Another more basic but equally useful metric is the assets-to-equity leverage ratio. On this measure, less than 10-12 times is considered normal for U.S. commercial banks.
First Niagara has a Tier 1 capital ratio of 15.6% and a leverage ratio of seven 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 tumultuous years, earnings have only fallen at an average annual rate of 6%. Meanwhile, the bank's quarterly dividend grew from $0.13 to $0.16 before the bank cut it in half this year to preserve capital so it can acquire HSBC's U.S. branches, which should help boost earnings.
The Foolish bottom line
Despite its recent dividend cut, First Niagara could actually turn out to be a dividend dynamo. Its capital levels are sure to come down following the acquisition, but they were quite high to begin with. Meanwhile, it has a fairly high yield, credit quality is strong, and payouts could see future increases given the expectation of future earnings growth. If you're looking for some great dividend stocks, I 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 nine other generous dividend payers -- simply click here.
At the time thisarticle was published Ilan Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter @TMFDada. 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.