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 4.9%, considerably higher than the S&P 500's 1.9%.
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 losses on early extinguishment of debt caused it to post an earnings loss over the past twelve months. Excluding those charges, however, Hudson City would have had a payout ratio of about 50%.
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 ratio is a commonly used leverage metric for banks that compares equity and reserves with total risk-weighted assets. When we're not in a non-financial crisis, a ratio above 13% is generally considered to be relatively conservative.
Hudson City doesn't disclose its tier 1 capital ratio in its quarterly filings, but its tangible capital ratio, a stricter metric, looks reasonable at 9.2%. One thing, however that investors should keep eye on -- in contrast to other banks, Hudson's credit quality has been declining over the past few years. Non-performing loans as a percentage of total loans have increased from 2.9% to 3.7% in just the past year, though the bank looks fairly well-provisioned.
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's normalized earnings per share have grown at an average annual rate of 4% while its quarterly dividend has increased from $0.075 to $0.08 per share.
The Foolish bottom line
So is Hudson City a dividend dynamo or a blowup? It's a bit of a complicated picture, but the bank appears to exhibit a fairly reasonable dividend bill of health. It has a rather large yield, a moderate payout ratio, manageable capital ratios, and a bit of growth to boot. Dividend investors will want to keep an eye on those increasing non-performing assets, though, to ensure that the Hudson's balance sheet remains in decent shape so it maintain and grow those payouts in the future.
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