How Long Can Ryland's Dividends Last?

Whether you're a beginning investor or a near-retiree, it's vitally important to pursue dividend-paying stocks. Companies with quarterly or annual payouts not only provide you with a steady stream of income, but also have the potential for capital appreciation. Simply put, dividend stocks can give your portfolio what almost no other investment can: both income and growth.

At The Motley Fool, we're avid fans of dividends -- and not just because we like that steady stream of cash. Studies have shown that from 1972 to 2006, stocks in the S&P 500 that don't pay dividends have earned an average annual return of 4.1%. Dividend stocks, however, have averaged a whopping 10.1% per year. You'd be crazy not to take advantage of that incredible difference!

Fair warning, though: Investing in dividends can be dangerous. Companies can cut, slash, or suspend their payouts at any time, often without notice. Fortunately, several warning signs may alert you to an impending cut. These red flags could be the crucial factor in determining whether or not a company will likely keep paying its dividend.

Today, let's take a closer look at Ryland Group (NYSE: RYL).

What's on the surface?
Ryland Group, which operates in the homebuilding industry, currently pays a dividend of 0.67%. That dividend yield may not seem like much, but considering that over 100 companies in the S&P 500 don't pay anything at all, it's nothing to complain about. Plus, don't forget, dividends typically grow with time, so that 0.67% has the potential to skyrocket over time.

But what's more important than the dividend itself is Ryland Group's ability to keep that cash rolling. Look at the company's reported dividends versus its reported earnings. If you happen to see dividend payments that are growing faster than earnings per share, it may be an initial signal that something just isn't right. Check out the graph below for details of the last five years:

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

Wow -- something just isn't right here. Clearly, Ryland Group has been maintaining its dividend at a rate that far exceeds its reported earnings, and investors should proceed with caution. It's possible that there may be a reason for this, so let's look further to see how much trouble we're actually in.

The more secure, the better
The payout ratio is one of the most common metrics investors use to judge a dividend's safety. This number tells you what percentage of net income gets paid out to investors in the form of a dividend. Normally, anything above 50% should spur you to look a bit further.

According to the most recent data, Ryland Group's payout ratio is N/A because of the company's negative earnings.

To sustain its dividend, Ryland's cash flow may be even more important than its payout ratio. Firms use free cash flow -- the cash left over after subtracting out capital expenditures -- to make acquisitions, develop new products, and of course, pay dividends! To evaluate Ryland's strength here, we can use a simple metric called the cash flow coverage ratio, which is cash flow per share divided by dividends per share. Normally, anything above 1.2 should make you feel comfortable; anything less, and you may have a problem on your hands.

Ryland Group's coverage ratio is 55.00 -- more than enough to make me feel comfortable about its cash flow situation.

Either way, it always helps to compare an investment with its most immediate competitors. In the chart below, I've included the above metrics with those of Ryland Group's closest rivals, along with the five-year dividend growth rate. If Ryland Group has grown dividends over the past five years, it's more likely to put shareholders first in the future as well. Check out how Ryland Group stacks up below:

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

The Foolish bottom line
In the end, only you can decide what numbers you're comfortable with. Sometimes, a higher yield and a greater reward require additional risk. When we look at Ryland Group's coverage ratio compared to its peer average, we see its dividend is probably more sustainable.

With anything -- a dividend, a share repurchase, or an ordinary earnings report -- you need to do your own due diligence. Looking at all of the numbers in the best context possible is just the best place to start.