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 Caterpillar (NYSE: CAT) 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.

Caterpillar yields 1.7%, a bit below the S&P 500's 2.1%.

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.

Caterpillar has a comfortable payout ratio of 24%.

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 Caterpillar stacks up next to its peers:


Debt-to-Equity Ratio

Interest Coverage

Caterpillar 258% 18 times
Illinois Tool Works (NYSE: ITW) 40% 14 times
Deere (NYSE: DE) 391% 6 times
Manitowoc (NYSE: MTW) 399% 1 time

Source: S&P Capital IQ.

In absolute terms, Caterpillar has a moderately high debt burden, though that's fairly normal for its capital-intensive industry. Caterpillar, Manitowoc, and Deere all carry large amounts of debt relative to their equity. Unlike Manitowoc, and to a lesser extent Deere, Caterpillar's interest coverage is incredibly strong -- though it's important to remember Caterpillar's operating income at currently quite high and tends to be cyclical.

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.


5-Year Earnings-Per-Share Growth

5-Year Dividend Growth

Caterpillar 7% 10%
Illinois Tool Works 8% 0%
Deere 17% 14%
Manitowoc (30%) 0%

Source: S&P Capital IQ.

Caterpillar, Illinois Tool Works, and Deere have all bounced back significantly from the economic downturn. Manitowoc, burdened by a major acquisition and hefty debt, is still trying to turn things around.

The Foolish bottom line
Because of its relatively low yield and cyclical nature, Caterpillar probably isn't exactly a dividend dynamo. But it does appear to exhibit a reasonably strong dividend bill of health. It has a modest payout ratio, a reasonable debt burden, and growth to boot. Dividend investors will want to keep an eye on the construction industry to ensure that the company's leverage doesn't become an issue should sales ultimately hit a bump.

If you're looking for some more certain dividend stocks, I suggest you check out "Secure Your Future With 11 Rock-Solid Dividend Stocks," a special report from The Motley Fool about some serious dividend dynamos. I invite you to grab a free copy to discover everything you need to know about these 11 generous dividend payers.

Ilan Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter, where he goes by @TMFDada. Motley Fool newsletter services have recommended buying shares of Illinois Tool Works. 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.