Limited Brands: 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 Limited Brands (NYSE: LTD) -- a holding of the Dada Portfolio I co-manage -- 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.

Limited Brands yields a whopping 4.7% -- considerably higher than the S&P 500’s 1.7%.

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 its dividend yield doesn’t seem particularly high.

Limited Brands’ payout ratio is a moderate 25%.

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.

Let's examine how Limited Brands stacks up next to its peers:

Source: Capital IQ, a division of Standard & Poor's.

Though its interest coverage appears manageable, Limited’s debt burden appears a bit higher than its peers’.

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.

Over the past five years, Limited Brands’ earnings have grown by 8% annually, while its dividend has grown by 2%.

The Foolish bottom line
Limited Brands exhibits a fairly clean dividend bill of health. It has a high yield, a modest payout ratio, and good earnings growth. Dividend investors will want to keep an eye on the company’s leverage and earnings stability.

To stay up-to-speed on the top news and analysis on Limited Brands, or any other stock, simply click here to add it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks by clicking here.

You can also follow the Dada Portfolio on Twitter @TMFDada. And as always, feel free to leave a comment here or hop on our discussion boards if you have any questions and thoughts!