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 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.
PDL BioPharma yields a whopping 9.5%, far higher than the S&P's 1.8%
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.
PDL BioPharma's payout ratio is a modest 19%.
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 PDL BioPharma stacks up next to its peers:
|PDL BioPharma||N/A||8 times|
Source: Capital IQ, a division of Standard & Poor's.
It's a bit unusual for pharmas to have negative equity, though PDL has fairly reasonable interest coverage.
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, PDL's operating income has grown at a 12% annual rate. Since the company doesn't perform new research, earnings depend on how well it is able to milk the remaining life of its existing patents.
The Foolish bottom line
PDL BioPharma exhibits a fairly clean – if fleeting -- dividend bill of health. It has a modest payout ratio and manageable debt. Dividend investors should be aware that the company's whopping yield has a lot to do with the fact that the company is in wind-down mode.
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Ilan Moscovitz doesn't own shares of any companies mentioned. You can follow him on Twitter @TMFDada. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.