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 CenturyLink (NYSE: CTL ) 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 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.
CenturyLink yields a whopping 8.8%, substantially higher than the S&P'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.
CenturyLink has a payout ratio of 143%, though on a free cash flow basis that figure shrinks considerably to 58%.
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 measure of a company's total debt burden.
Let's examine how CenturyLink stacks up next to its peers:
|
Company
|
Debt-to-Equity Ratio
|
Interest Coverage
|
|
CenturyLink
|
99%
|
3 times
|
|
Frontier (NYSE: FTR )
|
166%
|
2 times
|
|
Windstream (NYSE: WIN )
|
934%
|
2 times
|
|
AT&T (NYSE: T )
|
58%
|
6 times
|
Source: Capital IQ, a division of Standard & Poor's.
In absolute terms, CenturyLink has a moderate debt burden, though the integrated telecommunications industry tends to operate at higher debt levels due to its relatively reliable and capital-intensive nature.
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.
CenturyLink's earnings have fallen at an annual rate of 8% over the past five years, while its dividend has grown at a rate of 64%.
The Foolish bottom line
CenturyLink exhibits a reasonable dividend bill of health. It has a high yield and a moderate free cash flow payout ratio. Dividend investors will want to keep an eye on the company's earnings and free cash flow stability to ensure that its interest payments remain easily manageable and, hopefully, grow to support future dividend growth.
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