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 Paychex
1. Yield
First and foremost, dividend investors like a large 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.
Paychex yields 4.2% -- considerable and certainly worthy of further investigation.
2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company pays out in dividends to the amount it generates. 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.
Paychex's payout ratio is a fairly high 88%. Its free cash flow payout ratio is 80%.
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 five is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.
Paychex doesn't carry any debt.
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.
Let's examine how Paychex stacks up next to its peers:
|
Company |
5-Year Earnings-Per-Share Growth |
5-Year Dividend Growth |
|---|---|---|
|
Paychex |
4% |
16% |
|
Automatic Data Processing |
8% |
16% |
|
Fiserv |
4% |
0% |
|
Global Payments |
12% |
0% |
Source: Capital IQ, a division of Standard & Poor's.
The Foolish bottom line
Paychex exhibits a fairly reasonable dividend bill of health. Its payout ratio is a bit high, however, so dividend investors hoping to see increased payouts will want to watch for earnings growth to pick up.
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