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 Microsoft (Nasdaq: MSFT ) 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 Microsoft 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.
Microsoft 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.
Microsoft's payout ratio is a moderately low 38%.
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.
Microsoft carries a modest debt-to-equity ratio of 19%, and its interest payments are pretty insignificant.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Microsoft has managed to handle the global economic downturn pretty well. All told, earnings per share have grown at an average annual rate of 7% over the past five years, while dividends have grown at a 15% rate. The company's Business and Server divisions performed especially well, growing sales 11% earnings at an average of 16%, and for what it's worth, analysts do expect earnings growth to continue growing at about 10% annually or so over the coming years.
The Foolish bottom line
So, is Microsoft a dividend dynamo? It could very well be. The company has a moderately large yield, a reasonable payout ratio, easily manageable debt, and growth to boot.
If you want to find out even more about whether Microsoft is a buy or not, including the major opportunities for the software giant over the coming years, check out The Motley Fool's premium report on Microsoft.