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 Hudson City Bancorp (Nasdaq: HCBK ) 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 Hudson City 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.
Hudson City yields 4.6%, 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.
Hudson City doesn't have a payout ratio because the company failed to earn positive net income over the past 12 months. Adjusting for the bank's one-time loss on its extinguishment of debt and applying a standard tax, I'd estimate its adjusted payout ratio to be around 60%.
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 Tier 1 capital ratio is a commonly used leverage metric for banks that compares equity and reserves with total risk-weighted assets. In a non-financial crisis, a ratio above 13% is generally considered to be relatively conservative.
Hudson City hasn't actually revealed its Tier 1 ratio in its recent quarterly filings, except to say recently that "The Bank's Tier I leverage capital ratio was substantially unaffected by the extinguishments and Hudson City will continue to have a significant cushion above the regulatory requirements to be considered well capitalized." That is to say, above 10%.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Over the past five years Hudson City's operating income (before unusual items like the extinguishment charge) have grown at an average annual rate of 7%, while its dividend per share has grown at a 5% rate.
The Foolish bottom line
So is Hudson City a dividend dynamo? It's a mixed picture. The bank has a high yield, moderate payout ratio, probably a reasonable Tier 1 capital ratio, and growth to boot. And it seems to be taking many of the right steps to manage the fallout from the recent financial crisis. That being said, dividend investors will want to keep an eye on how successful the company's major balance sheet initiatives will be over the coming quarters before we can say whether Hudson truly is a dividend dynamo. If you're looking for some 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 – including Hudson City. I invite you to grab a free copy to discover everything you need to know about New York Community and the 10 other generous dividend payers – simply click here.