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.
Cisco yields 1.5% -- modest 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.
Cisco's payout ratio is a conservative 5%. The company prefers to return wealth to shareholders by repurchasing shares -- a whopping $6 billion in net repurchases over the past 12 months.
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.
Let's examine how Cisco stacks up next to its peers.
Interest Coverage Ratio
Source: Capital IQ, a division of Standard & Poor's.
Cisco's debt burden is on the high end among communications-equipment providers, but it's still modest on the whole.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Cisco's earnings per share have grown at a modest 8% over the past five years. It's a noob among dividend payers -- payouts were just instated in March.
The Foolish bottom line
Cisco exhibits a clean dividend bill of health. Its yield appears affordable and quite conservative. There seems to be quite a bit of room for a rise in dividends, though not quite as much as the 5% payout ratio would suggest, unless Cisco decides to reduce its generous share repurchases.