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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 Eli Lilly (NYSE: LLY ) 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 Eli Lilly 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.
Eli Lilly yields 4.7%, 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.
Eli Lilly has a moderate payout ratio of 51%.
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.
Eli Lilly has a debt-to-equity ratio of 37% and an interest coverage rate of 32 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.
All told, over the past five years, Eli Lilly's earnings per share have grown at an average annual rate of 12%, while its dividend has grown at a 4% rate. However, analysts expect earnings to actually decline over the next several years. Like many of its peers, the pharma giant will need to find new products to fill its pipeline.
The Foolish bottom line
On its surface, Eli Lilly looks like a dividend dynamo. It has a large yield, a moderate payout ratio, easily manageable debt, and historical growth to boot. Its payout ratio provides a large enough margin of safety for it to continue making these payouts even if earnings decline somewhat, as many expect them to. That being said, ideally dividend investors will want to see the company continue to produce new drugs to support or even grow its earnings and dividends for years to come.
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