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 ExxonMobil (NYSE: XOM ) 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 ExxonMobil 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.
ExxonMobil yields 2.6%, a fair bit 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.
ExxonMobil's payout ratio is a modest 21%. Of course, the E&P has to make considerable capital expenditures to find and develop new oil fields, so it often generates considerably less free cash flow than net income. On a free cash flow basis, the payout ratio rises to a moderate 41%.
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.
ExxonMobil carries an insignificant debt burden.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
ExxonMobil's earnings plunged dramatically along with energy prices during the global economic downturn in 2009, but they've since recovered. All told, earnings per share have grown at an average annual rate of 6% over the past five years, while dividends have grown at a 9% rate. For what it's worth, analysts do expect earnings growth to continue growing in the low single digits over the coming years.
The Foolish bottom line
So, is ExxonMobil a dividend dynamo? Perhaps. The company has a solid yield, a moderate payout ratio, and manageable debt. Of course, dividend investors will want to keep an eye on whether ExxonMobil is able to continue growing its earnings at a reasonable pace given the increasing costs and difficulty of tapping newer wells.
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