Nucor: Dividend Dynamo or Disaster?

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 see how Nucor (NYSE: NUE) 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 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.

Nucor yields 3.8% -- by far the highest of major U.S. steel producers, but not necessarily so high that it's 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.

Nucor's payout ratio is 298%, which means the company pays out nearly three dollars in dividends for every dollar it actually earns! That's because Nucor hasn't cut its dividend nearly as much as earnings have fallen in response to the recession's impact on sales. That ratio could come down if business picks up again, as it is showing signs of doing.

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.

With an interest coverage ratio of 3 times and a debt-to-equity ratio of 43%, Nucor's apparent interest burden seems to be a function of sluggish earnings rather than obscene debt.

4. Growth
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.

Let's examine how Nucor stacks up to its peers:

Source: Capital IQ, a division of Standard & Poor's. Averages are the median of medium- and large-cap U.S. industry components.

We see an industrywide reluctance to pare back dividends along with earnings shortfalls. Nucor, however, is the only member of the industry to pay a dividend large enough to exceed earnings (excluding U.S. Steel and Sims Metal Management (NYSE: SMS), which have negative earnings).

The Foolish bottom line
Nucor's dividend is not sustainable at current earnings levels (without the company issuing shares or weakening the balance sheet). This quarter brought higher steel prices, and Nucor's a fantastically well-run company, so an earnings recovery could be in the cards. But the economy isn't awesome, so if you like Nucor for its yield, realize you're also betting on Nucor's earnings recovering.