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Vector Group: Dividend Dynamo or the Next Blowup?

http://www.fool.com/investing/general/2012/03/05/vector-group-dividend-dynamo-or-the-next-blowup.aspx

Ilan Moscovitz
March 5, 2012

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 Vector Group (NYSE: VGR  ) stacks up in four critical areas to determine whether it's a dividend dynamo or a disaster in the making.

1. Yield
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.

Vector yields a whopping 8.9%, considerably higher than the S&P 500's 2%. That's also much higher than the other major tobacco producers. Of Altria (NYSE: MO  ) , Philip Morris International (NYSE: PM  ) , and Reynolds (NYSE: RAI  ) , Altria comes the closest to Vector's dividend, still clocking in well below at a 5.5% yield.

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, even when its dividend yield doesn't seem particularly high.

Vector has a massive payout ratio of 167%. Tobacco isn't a particularly capital-intensive industry, so it's normal for companies to have high payout ratios. That said, it's still unusual to have a payout ratio above 100%. Altria, Philip Morris, and Reynolds all generate enough earnings to cover their payouts.

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 five is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.

Let's examine how Vector stacks up next to its peers:

Company

Debt-to-Equity Ratio

Interest Coverage

Vector Group N/A 1.4 times
A