High-yielding dividend stocks can make for great investments because they allow you to earn a lot more in dividends than you would with the average stock.
Today, the average dividend yield for an S&P 500 stock is just under 1.5%. At that rate, to collect at least $1,000 in annual dividends, you would need to invest more than $67,000. That's not something most investors would likely have available to invest right now.
One stock that offers a much higher dividend yield is Medtronic (MDT 0.62%). At 3.4%, its yield is more than double what the S&P 500 offers. And the company has also increased its dividend payment for 46 straight years. But the medical device specialist's financials haven't been great in recent years, and there are concerns that the payout may be too high.
Does Medtronic make for a good income investment, or is the stock's dividend in danger of a cut?
Medtronic's payout ratio is around 90%
For dividend investors, a key metric that often gets a lot of focus is a stock's payout ratio. This tells investors how much of earnings a company is paying out in the form of dividends. If a business is paying out more than what it generates in profits, that would mean its payout ratio is more than 100%. Investors often get worried when a payout ratio is over 80%; Medtronic's is currently at around 90%.
The good news, however, is that this isn't exactly unchartered territory for Medtronic. Over the past few years, there has been some volatility in the company's earnings as the pandemic and supply chain issues disrupted operations for the healthcare industry.
MDT Payout Ratio data by YCharts
Medtronic's free cash flow is tight as well
Another number investors should also look to when evaluating a dividend's overall safety is free cash flow. This is how much a company generates in cash from its operating activities after deducting capital expenditures. Over the trailing 12 months, Medtronic's free cash has totaled just over $4 billion. While that's positive, it doesn't offer a huge buffer over the $3.6 billion that the medical device company has paid out in dividends over that same period.
The following chart shows the delta between free cash flow and dividend payments. Last quarter, which ended on Oct. 27, there was a shortfall of nearly $720 million.
Fundamental Chart data by YCharts
Cash flow can be volatile, and the encouraging takeaway for investors is that over the past five years, Medtronic has, on average, generated a buffer of around $475 million per quarter.
Is Medtronic's dividend safe?
Medtronic's dividend remains sustainable, but there's definitely some risk, particularly as the company continues to reinvest in its growth because that could put a strain on cash. But with supply chain problems abating and the overall conditions in the healthcare industry improving, Medtronic should be on a better path now.
Investors should monitor the company closely, however, to ensure that its financials are strengthening. While Medtronic's payout ratio is high, unless it stays high for long and the cash situation doesn't improve, I wouldn't expect the company to take the drastic measure of cutting its dividend or stopping its dividend growth streak. For now the dividend remains safe, but investors should keep a close eye on the stock.
