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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 Medtronic (NYSE: MDT ) 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 Medtronic 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.
Medtronic 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.
Medtronic's payout ratio is a modest 28%.
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.
Medtronic carries a moderate debt-to-equity ratio of 62% and a comfortable interest coverage rate of 13 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.
Medtronic has resisted the pressures of the global economic downturn fairly well. 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 17% rate. For what it's worth, analysts expect earnings to continue growing at about the same pace in the coming years.
The Foolish bottom line
So, is Medtronic a dividend dynamo? It's certainly a stable-looking dividend payer. The company has a moderate yield, a modest payout ratio, and manageable debt. Dividend investors might want to see a bit more earnings growth, but, given its small payout ratio, the company should have enough room to be able to continue raising its dividend faster than earnings for the time being.
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.