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.
Microsoft yields a moderate 2.9%, a bit better than the S&P 500's 2.2%.
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.
Microsoft has a payout ratio of 23%. That may seem somewhat miserly at first glance, but keep in mind that the company also spends approximately twice as much on share buybacks.
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.
Microsoft has a debt-to-equity ratio of 22% and interest coverage of 80 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 Microsoft stacks up next to its peers:
5-Year Earnings-per-Share Growth
5-Year Dividends-per-Share Growth
Source: S&P Capital IQ.
Two things stand out here: It's pretty unusual for companies in Microsoft's industry to pay a dividend at all. And despite its reputation as a company that's fallen a little behind the times, Microsoft is still growing earnings at a rapid pace.
The Foolish bottom line
Microsoft exhibits a clean dividend bill of health. It has a moderate yield, a reasonable payout ratio, a tiny debt burden, and growth. To stay up to speed on the top news and analysis on Microsoft, or any other stock, add it to your stock watchlist. If you don't have one yet, you can create a free, personalized watchlist of your favorite stocks.
Ilan Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter, where he goes by @TMFDada. The Motley Fool owns shares of BMC Software, Microsoft, and Oracle. Motley Fool newsletter services have recommended buying shares of Microsoft and VMware and creating a bull call spread position in Microsoft. 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.