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 CMS Energy
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.
CMS Energy yields 4.3% -- moderate and 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 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 if its dividend yield doesn’t seem particularly high.
CMS Energy’s payout ratio is a modest 47%.
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.
Let's examine how CMS Energy stacks up next to its peers:
|
Company |
Debt-to-Equity Ratio |
Interest Coverage |
|---|---|---|
|
CMS Energy |
252% |
2 times |
|
Consolidated Edison |
97% |
4 times |
|
PG & E |
113% |
3 times |
|
DTE Energy |
116% |
3 times |
Source: Capital IQ, a division of Standard & Poor's.
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.
CMS Energy swung to a gain in 2008 before earnings dropped off in 2009 and recovered in 2010. So it’s hard to choose a meaningful earnings growth time frame. Over the past five years, revenue has grown 0.4%.
The Foolish bottom line
While CMS Energy’s payout ratio seems reasonable should earnings continue to flow at their present rate, the company’s significant leverage leaves a small margin for error in case earnings volatility returns.
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