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 SeaDrill (NYS: SDRL) 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 SeaDrill 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.
SeaDrill yields a whopping 8.6%, 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.
SeaDrill has a payout ratio of 106%.
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.
SeaDrill has a debt-to-equity ratio of just 165% and an interest coverage rate of six 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 five years, SeaDrill's earnings per share have grown at an average annual clip of 38%. Its quarterly dividend has also grown considerably.
The Foolish bottom line
So is SeaDrill a dividend dynamo? It could very well be. The company has a massive yield, fairly manageable debt, and growth to boot. With such a large payout ratio, however, dividend investors hoping for payout increases are counting on the company continuing to grow its earnings -- as analysts expect it to. If you're looking for some other great dividend payers, 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 nine generous dividend payers -- simply click here.
At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned. You can follow him on Twitter@TMFDada. The Motley Fool owns shares of SeaDrill.Motley Fool newsletter serviceshave recommended buying shares of SeaDrill. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.