The S&P 500 (SNPINDEX: ^GSPC ) is a fruitful place to look for stocks that pay solid dividends. But even when a stock has an attractive dividend yield, one question you should always ask is whether that dividend is sustainable. Sometimes, you'll find that a high yield is misleading as it reflects a company that's stretched to the limit to finance its shareholder payouts. In other cases, you'll find stocks that have room to pay more in dividends. Let's take a look at Ford Motor (NYSE: F ) , Pfizer (NYSE: PFE ) , and Seagate Technology (NASDAQ: STX ) , focusing on their dividend policies and whether they could boost their payouts in the near future.
Ford currently pays $0.50 per share in annual dividends, which amounts to a 31% payout ratio based on trailing 12-month earnings as provided by S&P Capital IQ. Ford already carries a healthy dividend yield of more than 3% and raised its payout by 25% earlier this year, showing its commitment to restoring a substantial return of capital to shareholders after going almost six years without paying a dividend at all from 2006 to 2012. But a couple of things keep Ford from boosting its dividend too high. One is simply that the nature of Ford's business is cyclical, and so while the payout ratio looks ridiculously low right now, falling earnings during the next recession could make it look a lot more reasonable. Yet more specifically to current conditions, Ford is undergoing a massive slate of new and updated vehicle rollouts in the next year, including its premier F-150 pickup truck. Keeping capital on hand to handle any unexpected problems and also anticipating a temporarily drop in profits for 2014 is a smart display of prudent behavior for the automaker.
Pfizer boasts a 3.4% dividend yield, with the pharma giant having boosted its most recent dividend payment by 8%. But Pfizer's payout ratio of 30% is misleading for a simple reason: Pfizer's earnings were inflated over the past year by the sale of its interest in its Zoetis animal-health segment. In fact, that gain added more than $10 billion to Pfizer's bottom line, making its dividend look puny in comparison. Yet if you take out those one-time gains, you get an earnings payout ratio closer to 60%. That reflects a more than reasonable payout, especially given the lack of earnings growth that Pfizer is likely to face in the coming years until it can find new blockbuster drugs to replace lost revenue from off-patent medications.
Seagate Technology carries a dividend yield of 3.3% based on its 13% dividend increase late last year, and that puts its payout ratio at about 34%. For Seagate, the big question remains whether the former hard-disk drive specialist can make a successful transition to solid-state drives for use by mobile-device makers and enterprise customers. Seagate has done a good job of finding new applications that take advantage of its hard-disk expertise, including solid-state hybrid drives that are more cost-efficient than pure solid-state drives and permit higher volumes at the expense of some speed. With Seagate's earnings having fallen in recent years, though, it's makes sense for the company to figure out how to start growing again before it makes more dramatic increases in dividends.
Payout ratios are an important element of evaluating dividend stocks for future distribution increases, but they're not the only factor you should look at. In many cases, there are good reasons for companies to be a bit stingy in returning capital to shareholders, and that discipline can pay off for investors in the long run.
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