Whether you're a beginning investor or a near-retiree, it's vitally important to pursue dividend-paying stocks. Companies with quarterly or annual payouts not only provide you with a steady stream of income, but also have the potential for capital appreciation. Simply put, dividend stocks can give your portfolio what almost no other investment can: both income and growth.

At The Motley Fool, we're avid fans of dividends -- and not just because we like that steady stream of cash. Studies have shown that from 1972 to 2006, stocks in the S&P 500 that don't pay dividends have earned an average annual return of 4.1%. Dividend stocks, however, have averaged a whopping 10.1% per year. You'd be crazy not to take advantage of that incredible difference!

Fair warning, though: Investing in dividends can be dangerous. Companies can cut, slash, or suspend their payouts at any time, often without notice. Fortunately, several warning signs may alert you to an impending cut. These red flags could be the crucial factor in determining whether or not a company will likely keep paying its dividend.

Today, let's take a closer look at Cliffs Natural Resources (NYSE: CLF).

What's on the surface?
Cliffs Natural Resources, which operates in the steel industry, currently pays a dividend of 0.62%. That dividend yield may not seem like much, but considering that more than 100 companies in the S&P 500 don't pay anything at all, it's nothing to complain about. Plus, don't forget that dividends typically grow with time. That 0.62% has the potential to skyrocket in the decades to come.

But more important than the dividend itself is Cliffs Natural Resources' ability to keep that cash rolling. Look at the company's reported dividends versus its reported earnings. If you happen to see dividend payments that are growing faster than earnings per share, it may be an initial signal that something just isn't right. Check out the graph below for details of the last five years:

Source: Capital IQ, a division of Standard & Poor's.

Clearly, there doesn't seem to be a problem here. Cliffs Natural Resources has been able to boost its earnings at an adequate pace while keeping its dividends in check.

The more secure, the better
The payout ratio is one of the most common metrics investors use to judge a dividend's safety. This number tells you what percentage of net income gets paid out to investors in the form of a dividend. Normally, anything above 50% should spur you to look a bit further.

According to the most recent data, Cliffs Natural Resources' payout ratio is 8.36%. It's obvious that, at least on the surface, Cliffs Natural Resources should have no problem generating enough income to support its nice dividend of 0.62%.

To sustain that payout, Cliffs' cash flow may be even more important than its payout ratio. Firms use free cash flow -- the cash left over after subtracting out capital expenditures -- to make acquisitions, develop new products, and of course, pay dividends! To evaluate Cliffs' strength here, we can use a simple metric called the cash flow coverage ratio, which is cash flow per share divided by dividends per share. Normally, anything above 1.2 should make you feel comfortable; anything less, and you may have a problem on your hands.

Cliffs Natural Resources' coverage ratio is 10.57 -- more than enough cash on hand to keep pumping out that 0.62% yield. Barring any unforeseen circumstances, there really shouldn't be any major problems moving forward.

Either way, it always helps to compare an investment with its most immediate competitors. In the chart below, I've included the above metrics with those of Cliffs Natural Resources' closest competitors. In addition, I've included the five-year dividend growth rate, which is also a very important indicator. If Cliffs Natural Resources can illustrate that it's grown dividends over the past five years, there's a good chance that it will continue to put shareholders first in the future. Check out how Cliffs Natural Resources stacks up below:






Coverage Ratio

5-Year Compounded Dividend Growth Rate

Cliffs Natural Resources 0.62% 8.36% 10.57 29.49%
CONSOL Energy (NYSE: CNX) 0.78% 21.10% 0.48 7.39%
Allegheny Technologies (NYSE: ATI) 1.18% 94.54% -3.31 24.57%
Arch Coal (NYSE: ACI) 1.19% 54.85% 5.32 18.89%

Source: Capital IQ, a division of Standard & Poor's.

The Foolish bottom line
Only you can decide what numbers you're comfortable with in the end; sometimes, a higher yield and a greater reward require additional risk. However, when we look at Cliffs Natural Resources' payout ratio compared to its peer average, we see that it is a lower percentage, which illustrates that its dividend is probably more sustainable.

With anything -- a dividend, a share repurchase, or an ordinary earnings report -- you need to do your own due diligence. Looking at all of the numbers in the best context possible is just the best place to start.

Jordan DiPietro owns no shares of any of the companies mentioned in this article. 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.