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 Archer Daniels Midland
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.
ADM yields 2.2%, a tad bit higher than the S&P 500's 2%.
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.
ADM has a modest payout ratio of 28%.
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.
ADM has a moderate debt-to-equity ratio of 51% and an interest coverage rate of five times.
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.
Over the past five years, ADM's earnings per share have shrunk at an average annual rate of 1% -- though some of that was because of recent restructuring charges -- while its dividend has grown at a 10% rate.
The Foolish bottom line
So is ADM a dividend dynamo? Not yet, since its yield and earnings growth could be a bit higher, though ADM could very well have what it takes to eventually become a dividend dynamo. It has a decent yield, a modest payout ratio, and manageable debt. Dividend investors will want to keep an eye on earnings growth and dividend growth, which should be able to continue growing in excess of the former because of that low payout ratio. However, 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. I invite you to grab a free copy to discover everything you need to know about these 11 generous dividend payers -- simply click here.
