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.
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.
Applied Materials yields 2.3% -- moderate and certainly not 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 with 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.
Applied Materials' payout ratio is a conservative 24%.
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 measurement of a company's total debt burden.
Applied Materials has negligible debt.
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 Applied Materials stacks up next to its peers.
5-Year Earnings-Per-Share Growth
5-Year Dividend-Per-Share Growth
Source: Capital IQ, a division of Standard & Poor's.
Applied Materials has grown earnings at a healthy clip over the past five years, though not at the breathtaking rate of many of its peers. On the other hand, it's somewhat rare to find dividend payers in Applied Materials' space.
The Foolish bottom line
Applied Materials exhibits a clean dividend bill of health. Its moderate yield appears affordable and actually quite conservative. There seems to be quite a bit of room for a rise in dividends, particularly if Applied Materials continues to grow its earnings.
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Ilan Moscovitz doesn't own shares of any company mentioned. The Motley Fool owns shares of Applied Materials. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.