When going dividend hunting, investors shouldn't just pick the highest-yielding stocks. Instead, investors should carefully scout for companies capable of sustaining their future dividend payouts, without straining their balance sheet. Plus, these companies should have ample dividend cushioning to reward their investors with future dividend hikes.

Let's take a look at AT&T (NYSE:T), Verizon (NYSE:VZ), and Windstream (NASDAQ:WIN) and find out if these companies deserve a place in an income investor's portfolio.

Capital structure
Analyzing a company's capital structure and its debt load provides vital insights about the sustainability of its future dividend payouts. Investors should note that dividends are paid out from post-tax net income, that is, after interest and tax expenses have been borne by the company. Income-seeking investors should, therefore, consider investing in companies with moderate net-debt levels.

 

Debt/Equity

Debt/Capitalization

AT&T

0.8x

45%

Verizon

2.4x

70%

Windstream

10.4x

91.2%

As illustrated in the table above, AT&T and Verizon have a fairly large debt-to-equity ratio. But their relatively modest debt-to-capital ratio suggests the companies also have substantial chunks of equity funding their daily operations and investments. This, in turn, suggests the companies aren't straining their balance sheets to fund their dividend payouts.

In contrast, Windstream is extremely leveraged. The company is using debt as its primary source of capital to fund its operations and dividend payouts. This puts Windstream in a financially precarious position, as it may have to slash its dividends if its operating income takes a hit in the future.

Dividend sustainability
Income-seeking investors should also closely monitor their investments' free cash flow generation. This figure represents the amount of cash a company is left with to reward its investors with dividend payouts, after bearing its capital expenditures and operating expenses.

 

TTM FCF

TTM Dividend Payout

FCF Payout Ratio

Cash & Equivalents

AT&T

$14.42 billion

$9.59 billion

66.5%

$3.6 billion

Verizon

$21.78 billion

$9.13 billion

42%

$2.9 billion

Windstream

$0.99 billion

$595 million

60.1%

$80.6 million

It's evident from the table above that AT&T, Windstream, and Verizon paid out a modest part of their free cash flows as dividends over the last 12 months, leaving ample dividend cushioning for future dividend hikes.

It's also worth noting that AT&T and Verizon have ample cash and equivalents to support their dividend payouts in case of an economic downturn. Windstream's cash and equivalents, on the other hand, appear insufficient for supporting even 15% of its annualized dividend payouts.

Securing growth
Investing in growing companies also contributes to securing and stabilizing future dividend income.

 

 TTM ROIC

Capital Expenditure YOY Change

AT&T

11.4%

5.6%

Verizon

11%

3.3%

Windstream

2.4%

(33.1%)

Evidently, AT&T and Verizon are heavily investing in growth; their impressive ROIC ratios highlight their ability to generate handsome returns from these investments. When these returns are carried onto the bottom line, the mentioned companies will be better equipped to sustain and hike their future dividend payouts.

In contrast, Windstream has substantially slashed its capital expenditures over the last 12 months. This may have stabilized its free cash flows, but might as well hamper its growth over the longer run -- something that will make it difficult for Windstream to sustain and hike its dividend payouts in the future.

Wrap up
The bottom line is, AT&T and Verizon appear to be financially capable of rewarding their investors with future dividend hikes, while Windstream does not. For this reason, it's probably best to avoid Windstream for income generation purposes.

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Piyush Arora has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.