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 Caterpillar (NYSE: CAT ) stacks up in four critical areas to determine whether it's a dividend dynamo or a disaster in the making.
1. Yield
First and foremost, dividend investors like a large 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.
Caterpillar yields 1.7% -- modest and certainly not cause for alarm.
2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company pays out in dividends with the amount it generates. 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.
Caterpillar's payout ratio is a conservative 30%.
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 measurement of a company's total debt burden.
Let's examine how Caterpillar stacks up next to its peers.
|
Company
|
Debt-to-Equity Ratio
|
Interest Coverage Ratio
|
| Caterpillar |
226% |
16 times |
| Deere (NYSE: DE ) |
351% |
N/A |
| Illinois Tool Works (NYSE: ITW ) |
32% |
14 times |
| Manitowoc (NYSE: MTW ) |
437% |
1 time |
Source: Capital IQ, a division of Standard & Poor's.
Like many of its peers, Caterpillar bears a considerable debt burden. Though current earnings easily cover interest payments, the return of a global economic slowdown could put pressure on the dividend, particularly in light of the industry's leverage.
4. Growth
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Caterpillar's earnings per share have grown at 5% over the past five years, while its dividend has grown at 12%.
The Foolish bottom line
Under current economic conditions, Caterpillar exhibits a fairly clean dividend bill of health. Its yield appears affordable and quite conservative. The company's considerable leverage and cyclical industry put payouts at some risk should sales hit a bump.
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