Verizon: Dividend Dynamo or Blowup?

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.

Let's examine how Verizon (NYSE: VZ) stacks up in four critical areas to determine whether it's a dividend dynamo or a disaster in the making.

1. Yield
First and foremost, dividend investors like a large forward 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.

Verizon yields 5.4% -- moderate 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 paid out in dividends last year to the earnings it generated. 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, even when the dividend yield doesn't seem particularly high.

Verizon's payout ratio is a whopping 154%. On a free cash flow basis, however, the payout ratio is 39%. The answer to Verizon's ability to keep paying dividends is somewhere in between these figures. For example, Verizon's cash flow payout looks extremely low, but the company adds back income attributable to Vodafone (Nasdaq: VOD), a minority owner of Verizon Wireless. This creates an accounting cash flow figure that's overstated past its actual realities.

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 five is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.

Verizon's debt-to-equity ratio is 69%. Its interest coverage rate is seven times.

4. Growth
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 Verizon stacks up next to its peers:

Source: Capital IQ, a division of Standard & Poor's. *Negative earnings. **Apple and Sprint Nextel do not pay a dividend.

The Foolish bottom line
Verizon exhibits a reasonable dividend bill of health. Its earnings payout ratio and earnings-per-share growth rates are the major areas of concern, though each of these metrics look considerably better on a free cash flow basis.

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