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.
Alaska Communications yields 9.9% -- high and worthy of further investigation.
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.
Alaska Communications failed to generate earnings over the past 12 months. Its free cash flow payout ratio is 77%, but that reflects some large deferred tax benefits. If we remove those benefits, the free cash flow payout ratio climbs to 349%.
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 measure of a company's total debt burden.
Let's examine how Alaska Communications stacks up next to its peers.
Interest Coverage Ratio
Source: Capital IQ, a division of Standard & Poor's.
Alaska Communications' interest coverage looks a bit slim, and the company has negative equity.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Alaska Communications lost money last year. Over the past five years, Alaska Communications' revenue has grown 0.8% annually, while its dividend has grown at 1.1%.
The Foolish bottom line
Alaska Communications exhibits several dividend warning signs, including a lack of earnings, high free cash flow payout ratio, and considerable leverage.
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Ilan Moscovitz doesn't own shares of any company mentioned. Motley Fool newsletter services have recommended buying shares of AT&T. 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.
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