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 Duke Energy
1. Yield
First and foremost, dividend investors like a large 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.
Duke yields 5.7% versus its industry average of 4.9%. That's high, but not in itself cause for alarm.
2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company pays out in dividends to the amount it generates. 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.
Duke's payout ratio is 180%, which means the company pays out nearly $2 in dividends for every dollar in it actually earns! When we exclude non-cash writedowns on its Midwest operations, however, that number declines significantly.
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.
With an interest coverage ratio of 2.7 and a debt-to-equity ratio of 84%, Duke appears to depend on the relative stability of its business.
Let's examine how Duke stacks up to its peers:
|
Company |
Interest Coverage Ratio |
Debt-to-Equity Ratio |
|---|---|---|
|
Duke |
2.7 |
84% |
|
PPL |
2.5 |
116% |
|
Progress Energy |
2.6 |
129% |
|
Southern Company |
4.0 |
132% |
|
Median Electric Utility |
2.8 |
135% |
Source: Capital IQ, a division of Standard & Poor's. Median is of medium- and large-cap U.S. industry components.
Duke's leverage seems a bit worrisome in absolute terms, but when we look at it in the context of electric utilities, things don't look so bad.
4. Growth
A large dividend is nice; a large, growing dividend is even better. To support an expanding dividend, we also want to see earnings growth.
Duke's earnings have shrunk at a 23% rate over the past five years, while its dividend has only shrunk at an average 3% rate. (The median electric utility is roughly 4% growth for both earnings and dividends.) However, management projects a strong rebound in earnings this year. If projections are accurate, it should be more than enough to cover its current dividend.
The Foolish bottom line
Duke exhibits a few yellow flags -- high payout ratio and low interest coverage -- that upon closer inspection turn out to be not as troubling as they appear at first. Still, dividend investors would want to keep an eye on Duke's earnings and dividend growth.
