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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 AT&T (NYSE: T ) 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 AT&T 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.
AT&T yields a whopping 5.9%, quite a bit higher than the S&P 500 2.1%.
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.
AT&T has a fairly high payout ratio of 86%, though on a free cash flow basis it falls to 65%.
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 AT&T stacks up next to its peers.
|Verizon (NYSE: VZ )||63%||9 times|
|Sprint Nextel (NYSE: S )||142%||1 times|
Source: S&P Capital IQ.
Telcos tend to carry a fair bit of debt, but that's because they operate in a stable industry that's capital-intensive.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
5-Year Annual Earnings-per-Share Growth
5-Year Dividend-per-Share Growth
Sources: S&P Capital IQ.
*Negative earnings per share.
The Foolish bottom line
AT&T exhibits a reasonable dividend bill of health. Despite its high yield and payout ratio, the company currently generates enough cash to afford those payouts. Debt appears manageable as well. Dividend investors will want to keep an eye on the company's earnings growth to ensure that it's able to continue raising its payouts in the future.
If you're looking for other great dividend stocks, check out "Secure Your Future With 11 Rock-Solid Dividend Stocks," a special report from the Motley Fool about 11 dividend dynamos -- including AT&T. I invite you to grab a free copy to discover everything you need to know about the other 10 dividend payers.