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.
General Electric yields 3.1% -- 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.
General Electric's payout ratio is 40%, which is fairly conservative.
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.
General Electric's debt-to-equity ratio is 371%, largely because of its extensive financing division. This may seem like a lot (and it is), but it's not as bad as it seems, because that debt is cheap: GE's operating earnings cover its interest payments 12 times over.
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 General Electric 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.
General Electric's been the laggard of industrial conglomerates, largely because of its overexposure to finance leading into the financial crisis.
The Foolish bottom line
General Electric made the right call by reducing its dividend in 2009 to what appears to be a fairly stable and rising level today. Leverage remains an issue, though -- should we experience another financial crisis, there's a strong chance the dividend could be affected again.
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Ilan Moscovitz doesn't own shares of any company mentioned. Motley Fool newsletter services have recommended buying shares of 3M. 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.