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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 National Presto Industries (NYSE: NPK ) 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 National Presto 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.
While you won't see the figure reported on most financial websites, if you include National Presto's "special" annual dividends, the stock yields 8.3%, considerably higher than the S&P 500's 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.
National Presto has a payout ratio of 100%.
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 five is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.
National Presto doesn't carry any debt.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Let's see how National Presto stacks up next to its peers:
5-Year Earnings-per-Share Growth
5-Year Dividends-per-Share Growth
Source: S&P Capital IQ.
That's not to say that we'll see these growth rates necessarily continue for the next five years -- though analysts generally seem to be projecting similar growth rates ahead for these companies. The defense industry could be staring at big cuts down the road should we see reduced military spending, as is currently being discussed on Capitol Hill.
The Foolish bottom line
National Presto may very well be a dividend dynamo. It has an enormous yield, carries no debt, and has a history of earnings growth. On the other hand, barring a major increase in orders, investors shouldn't expect to see too much growth in the company's dividend because of its high payout ratio.
If you're looking for some other great dividend stocks, I suggest you check out "Secure Your Future With 11 Rock-Solid Dividend Stocks," a special report from The Motley Fool about some serious dividend dynamos. I invite you to grab a free copy to discover everything you need to know about these 11 generous dividend payers -- simply click here.