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.
PepsiCo yields 3.3%, a bit higher than the S&P'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.
PepsiCo has a payout ratio of 49%.
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.
PepsiCo has a debt-to-equity ratio of 112% and an interest coverage rate of 10 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 PepsiCo stacks up next to its peers.
Dr Pepper Snapple
Source: S&P Capital IQ.
The Foolish bottom line
PepsiCo exhibits a clean dividend bill of health. It has a nice yield, a modest payout ratio, a reasonable debt burden, and moderate growth. To stay up to speed on PepsiCo's progress, add it to your stock watchlist. If you don't have one yet, you can create a free, personalized watchlist of your favorite stocks.