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 Procter & Gamble (NYSE: PG ) 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 Procter & Gamble 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.
Procter & Gamble yields 3.4%, 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.
Procter & Gamble's payout ratio is a moderate 57%.
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.
Procter & Gamble carries a moderate debt-to-equity ratio of 47% and a comfortable interest coverage rate of 21 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 global economic downturn has certainly had an impact on P&G. All told, earnings per share have barely grown over the past five years, though dividends have grown at an 11% rate. For what it's worth, analysts do expect earnings growth to improve to 7% or so over the coming years.
The Foolish bottom line
So, is Procter & Gamble a dividend dynamo? It could very well be. The company has a large yield, a moderate payout ratio, and manageable debt. Of course, dividend investors will still want to keep an eye on whether P&G's expected earnings growth materializes over the coming years.
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 -- including P&G. I invite you to grab a free copy to discover everything you need to know about the nine generous dividend payers.