Will Duke Energy's Dividends Last?

Whether you're a beginning investor or a near-retiree, the importance of purchasing stocks that pay dividends cannot be overstated. Not only do companies that have quarterly or annual payouts provide you with a steady stream of income, they also have the potential for capital appreciation. Simply put, dividend stocks can you give your portfolio what almost no other investment can -- both income and growth.

At The Motley Fool, we're avid fans of dividends -- and not just because we like that steady stream of cash. Studies have shown that from 1972 to 2006, stocks in the S&P 500 that don't pay dividends have earned an average annual return of 4.1%; dividend stocks, however, have averaged a whopping 10.1% per year. That is an incredible difference -- one that you'd be crazy to not take advantage of!

But investing in dividends can be dangerous -- companies can cut, slash, or suspend dividends at any time, often without notice. Fortunately, there are several warnings signs that may alert you, and these red flags could be the crucial factor in determining whether or not a company is likely to continue paying its dividend. Today, let's drill beneath the surface and check out Duke Energy (NYSE: DUK  ) .

What's on the surface?
Duke Energy, which operates in the electric utilities industry, currently pays a dividend of 5.76%. That's certainly nothing to sneeze at, as the average dividend payer in the S&P 500, in 2009, sported a yield of 2%.

But what's more important than the dividend itself is Duke Energy's ability to keep that cash rolling. The first thing to look at is the company's reported dividends versus its reported earnings. If you happen to see dividend payments that are growing faster than earnings per share, it may be an initial signal that something just isn't right. Check out the graph below for details of the past five years:

Wow -- something just isn't right, here. Clearly, Duke Energy has been boosting its dividend at a rate that is far above that of its reported earnings, and investors should proceed with caution. It's possible that there may be reason for this, so let's look further to see how much trouble we're actually in.

The more secure, the better
One of the most common metrics that investors use to judge the safety of a dividend is the payout ratio. This number tells you what percentage of net income is paid out to investors in the form of a dividend. Normally, anything above 50% is cause to look a bit further. According to the most recent data, Duke Energy's payout ratio is 180.24%. Duke Energy is obviously paying out a substantial portion of its net income in the form of a dividend. This isn't necessarily a bad thing -- companies can increase their payout ratios over time, possibly because they are becoming more mature, or possibly because that's the best way to increase shareholder value. What's important is if there's enough cash on hand to support that high payout ratio, so let's look at free cash flow.

Free cash flow -- all the cash left over after subtracting out capital expenditures -- is used by firms to make acquisitions, develop new products, and of course, pay dividends! We can use a simple metric called the cash flow coverage ratio, which is cash per share divided by dividends per share. Normally, anything above 1.2 should make you feel comfortable; anything less, and you may have a problem on your hands. Duke Energy's coverage ratio is -0.10, which isn't nearly enough to make me feel comfortable as an investor. There could be a number of reasons the number is so low -- maybe it's typical for the industry, maybe there's a significant amount of debt coming due, or maybe Duke Energy is simply less than stellar at managing its assets.

Either way, it's always beneficial to compare an investment with its most immediate competitors, so in the chart below, I've included the above metrics with that of Duke Energy's closest competitors. In addition, I've included the five-year dividend growth rate, which is also a very important indicator. If Duke Energy can illustrate that it's grown dividends over the past five years then there's a good chance that it will continue to put shareholders first in the future. Check out how Duke Energy stacks up below:

Company

Dividend

Yield

Payout

Ratio

Coverage Ratio

5-Year Compounded Dividend Growth Rate

Duke Energy

5.76%

180.24%

-0.10

-2.69%

Southern (NYSE: SO  )

5.08%

70.17%

-0.24

4.11%

Exelon (NYSE: EXC  )

5.08%

54.78%

1.44

6.89%

Dominion Resources (NYSE: D  )

4.17%

42.34%

-0.39

6.20%

NextEra Energy

3.84%

42.83%

-2.78

6.95%

PG&E

3.98%

52.79%

-1.48

23.87%

American Electric Power

4.73%

67.79%

-0.39

3.34%

The Foolish bottom line
Only you can decide what numbers you're comfortable with in the end; sometimes a higher yield and a higher reward means additional risk. However, in this situation, Duke Energy's payout ratio seems to be above the peer average, which means if you're a prudent investor, you may want to look elsewhere for the most secure payment possible The bottom line, however, is to make sure that with anything -- whether it be a dividend, a share repurchase, or an ordinary earnings report -- you do your own due diligence. Looking at all of the numbers in the best context possible is just the best place to start.

Jordan DiPietro owns shares of Exelon. Exelon is a Motley Fool Inside Value selection. Dominion Resources, Duke Energy, and Southern are Motley Fool Income Investor selections. The Fool owns shares of and has written covered calls on NextEra Energy. Motley Fool Options has recommended writing puts on Exelon. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 20, 2010, at 12:31 PM, AFKCobra wrote:

    The labels on the graph are incorrect. The diluted EPS should be the red line, which according to Yahoo is 52 cents per share. Also, on Yahoo the dividend is .98, which is way lower than the blue line that should be the dividend. Did you plot the correct data? Is there an editor for checking the accuracy of the report?

  • Report this Comment On August 20, 2010, at 1:04 PM, asboeagle wrote:

    The five year dividend growth rate does not include the fact that DUKE spun off Spectra in 2007. The EPS on Yahoo per analysts is $1.25 to 1.48 so the pay out ratio is incorrect.

    i agree with need for editorial checking.

  • Report this Comment On August 20, 2010, at 1:35 PM, baseballbill730 wrote:

    I have owned DUK since 1998 and while its performance since then has been less than stellar, that performance is certainly not represented by this article. Since the spinoff of Spectra Energy occurred at the end of 2006, perhaps there has not been enough time to prove the author's thesis. Whatever the case, this article should be completely ignored.

  • Report this Comment On August 20, 2010, at 2:23 PM, TMFPhillyDot wrote:

    The graph, indeed, is incorrect. We are sorry for the error and the correct graph with appropriate data will be uploaded and changed momentarily.

    Again, we apologize for the error.

    Foolishly,

    Jordan (TMFPhillyDot)

  • Report this Comment On August 20, 2010, at 2:26 PM, TMFPhillyDot wrote:

    @baseballbill730,

    I agree with you that it is not a completely fair comparison considering the spin-off of Spectra in 2006. I guess my hope with the article was to present an objective view of what DUK's dividend situation looks like today, regardless of the past.

    However, you are right to do your own due diligence and thank you for your comment.

    Best,

    Jordan (TMFPhillyDot)

  • Report this Comment On August 20, 2010, at 5:15 PM, rgperrin wrote:

    Roger Conrad, publisher of Utility Forecaster, takes decided exception this article.

  • Report this Comment On August 20, 2010, at 9:45 PM, lemoneater wrote:

    I appreciated your article. It is helpful to have several ways to critique dividend stocks. I own DUK because it provides a lot of the power in my area and because I got to visit a nearby power plant--most enjoyable. All that to say even though I like a company I still find objective analysis a helpful balance to my enthusiasm. Have a good evening!

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