In the dividend report card series, we analyze financial metrics to begin answering the following questions about a company's dividend:

  1. Over time, has this company steadily increased its payouts?
  2. How sustainable is the dividend?
  3. Does the company have room to further increase the dividend?

For a full explanation of each category, click here for a tutorial.

Today's pupil is Diageo (NYSE: DEO), which has a 3.2% yield.

Dividend history

Metric

5-Year Annualized Growth Rate

Dividend per share 5.2%
Diluted earnings per share 9.1%

Source: Capital IQ, a division of Standard & Poor's.

Diageo has an enviable track record of raising dividends, having boosted payouts each year for well over a decade. The rolling five-year growth rate, however, has declined from 7.1% in 2005 to 5.2% today.

Past returns don't guarantee future results, however, so dividend history is only 10% of the final grade. That said, for this category, Diageo scores a 3 of 5.

Sustainability

 Metric

Trailing 12 Months

Final Grade
Weighting

Report Card Score
(out of 5)

Interest coverage 3.2 times 10% 3
EPS payout ratio 56.1% 10% 4
FCFE payout ratio 74.6% 30% 4

Source: Capital IQ.

Diageo continues to generate more than enough profits and free cash flow to cover its dividend, which is an encouraging sign of sustainability. The interest coverage ratio is still a little lower than I'd prefer, but Diageo has an "A-" credit rating from Standard & Poor's and appears to have no problem paying its creditors.

Growth

Metric 

Trailing 12 Months

Final Grade
Weighting

Report Card Score
(out of 5)

EPS payout ratio 56.1% 10% 3
FCFE payout ratio 74.6% 20% 3
Sustainable growth rate 20.2% 10% 5

In August, management said it was "recommending a 6% increase in the final dividend" and that they "anticipate at least maintaining this rate of dividend growth in fiscal [year] 2011."

Diageo certainly has the ability to grow its dividend at a steady clip in the coming years, but investors shouldn't get their hopes up for high single-digit annualized growth.

Competitors
An "ungraded" section of the dividend report card involves see how a stock's current yield stacks up against direct competitors'. If it's too high relative to competitors' yields, the board could be tempted to slow the growth rate, or vice versa, to bring it more in line with the industry average.

Company

Dividend Yield

Fortune Brands (NYSE: FO) 1.2%
Constellation Brands (NYSE: STZ) N/A
Brown-Forman (NYSE: BF-B) 1.9%

Diageo's dividend yield of 3.2% is above its peer group average, but that may change a bit when Fortune Brands spins-off its premium spirits business, as that segment has generated good free cash flow in the past. My guess is the separate entity would pay a higher dividend than the current group. That may bring Diageo's yield more in line with its peers.

Pencils down!
With all the numbers in, here's how Diageo's dividend scored:

Weighting

Category

Final Grade

10%

History

3

  Sustainability  

10%

Interest Coverage

3

10%

EPS Payout Ratio

4

30%

FCFE Payout Ratio

4

  Growth  

10%

EPS Payout Ratio

3

20%

FCFE Payout Ratio

3

10%

Sustainable growth

5

100%

Total Score (Out of 5)

3.6

  Final Grade

B-

Diageo's free cash flow cover has declined slightly over the past six months because of increased capital investments. Free cash flow can be volatile from period to period, so it isn't a major cause for concern. Still, it's worth keeping an eye on going forward to make sure a trend isn't developing.

Want some more dividend ideas? Click here for a free report from Motley Fool expert analysts called "13 High-Yielding Stocks to Buy Today."

Todd Wenning is the advisor of Motley Fool UK Dividend Edge. He does not own shares of any company mentioned. Diageo is a Motley Fool Income Investor recommendation. Fortune Brands is a Stock Advisor recommendation. The Fool owns shares of Diageo and has a disclosure policy.