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.
Applied Materials yields 3%, substantially higher than the S&P's 1.9%.
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.
Applied Materials has a payout ratio of 20%.
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.
Applied Materials has a debt-to-equity ratio of 23% and interest coverage of 66 times.
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 Applied Materials 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. *Not applicable because these companies don't issue a dividend.
Like its peers, Applied Materials has enjoyed pretty solid earnings growth over the past five years. It's fairly unusual among semiconductor equipment companies for offering a dividend.
The Foolish bottom line
Applied Materials exhibits a clean dividend bill of health. It has a solid yield, a modest payout ratio, limited debt, and strong historical growth.
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Ilan Moscovitz doesn't own shares of any companies mentioned. You can follow him on Twitter @TMFDada. The Motley Fool owns shares of Applied Materials. 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.
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