ConocoPhillips: Dividend Dynamo or Blowup?

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 simply not enough to buy a high yield. You also need to make sure those payouts are sustainable.

Let's examine how ConocoPhillips (NYSE: COP) 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.

ConocoPhillips yields 3.6% -- 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 when its dividend yield doesn’t seem particularly high.

ConocoPhillips' payout ratio is a modest 27%. On a free cash flow basis, it’s a bit higher at 63%.

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 ConocoPhillips stacks up next to its peers:

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

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.

Over the past five years, ConocoPhillips’ earnings per share have shrunk by 3% annually, while its dividend has risen at a 12% rate.

The Foolish bottom line
ConocoPhillips exhibits a fairly clean dividend bill of health. Its leverage and payout ratios appear reasonable. Dividend investors will want to watch the company to make sure it’s able to grow earnings.

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