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 American Eagle Outfitters
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.
American Eagle Outfitters yields 3.1%, quite a 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.
American Eagle Outfitters has a moderate payout ratio of 45%.
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.
American Eagle Outfitters doesn't carry any debt.
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.
The current economic downturn hasn't been terribly kind to American Eagle. All told, over the past five years, earnings per share shrunk at an average annual rate of 9%, while its dividend has grown at a 12% rate.
The Foolish bottom line
With the troubles facing American Eagle's business, it's probably difficult to call the company a dividend dynamo, but is it a blowup? Dividends have been increasing in recent years alongside declining earnings that analysts expect to fall once again this year. The falling earnings is cause for concern, but given American Eagle's moderate payout ratio and debt-free condition, it should be able to maintain its dividend -- if it decides to, and if it's able to stop the bleeding at the levels analysts think it will be able to.
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