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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 UPS (NYSE: UPS ) 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 UPS 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.
UPS yields 3%, quite a bit 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.
UPS's payout ratio is a moderate 53%.
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.
UPS's debt-to-equity ratio is rather large at 160%, but its interest is well covered at 17 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.
The economic downturn obviously shook things up a bit for companies that depend on global shipping volumes, but earnings at UPS have been pretty resilient. All told, over the past five years UPS's earnings per share increased at an annual rate of 1%, while its dividend increased at a 6% rate. Analysts expect earnings growth to continue picking up.
The Foolish bottom line
So is UPS a dividend dynamo? It could very well be. The company exhibits a solid yield, a moderate payout ratio, reasonable debt, and growth to boot. If you're looking for some other great dividend stocks, check out "Secure Your Future With 9 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 nine generous dividend payers.