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 3M (NYSE: MMM ) 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 3M 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.
3M yields 2.7%, 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.
3M has a modest payout ratio of 36%.
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.
3M has a fairly small debt-to-equity ratio of 33% and a sizeable interest coverage of 33 times.
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, 3M's earnings per share have grown at a modest average annual rate of 3%, while its dividend has grown at a 4% rate.
The Foolish bottom line
So, is 3M a dividend dynamo? It could very well be. With a moderately large yield, a modest payout ratio, a small debt burden, and a bit of growth to boot, it certainly has a safe payout. Dividend investors will want to keep an eye on whether the company is able to boost its earnings growth rate -- as analysts expect -- though the low payout ratio means 3M could probably raise its dividend in excess of its earnings growth anyway should it decide to do so. 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.