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 Freeport-McMoRan (NYSE: FCX ) 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 Freeport-McMoRan 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.
Freeport-McMoRan yields 3.5%, considerably 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.
Freeport-McMoRan's payout ratio is a modest 32%.
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.
Freeport-McMoRan carries a rather small debt-to-equity ratio of 18% and a comfortable interest coverage rate of 26 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.
Considering the global economic downturn, Freeport-McMoRan's earnings have actually held reasonably steady for a commodity producer (the huge loss in 2008 was an accounting charge resulting from asset writedowns). Earnings have dropped off a bit in the past year as copper prices softened. All told, earnings per share have shrunk at an annualized rate of 5% over the past five years, while dividends have grown at an 11% rate. For what it's worth, analysts expect an average of low single-digit earnings growth over the coming years.
The Foolish bottom line
So, is Freeport-McMoRan a dividend dynamo? Perhaps. It has a large dividend yield, a modest payout ratio, and manageable debt. The only major weakness for this dividend payer appears to be its so-far limited earnings growth, so dividend investors will want to keep an eye on whether the company is able to turn that around.
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