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 FirstEnergy
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.
FirstEnergy yields 5% -- moderate and certainly worthy of further consideration.
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.
FirstEnergy’s payout ratio is a whopping 102%. On a free cash flow basis, however, the figure drops to 60%, due in part to writedowns.
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 FirstEnergy stacks up next to its peers:
|
Company |
5-Year Annual Earnings-per-share growth |
5-Year Annual Dividend Growth |
|---|---|---|
|
FirstEnergy |
153% |
3 times |
|
Entergy |
136% |
4 times |
|
Edison International |
110% |
3 times |
|
Public Service Enterprise |
89% |
6 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.
Over the past five years, FirstEnergy’s earnings per shares declined by 6% annually, while its dividend rose at a 5% rate.
The Foolish bottom line
FirstEnergy exhibits a fairly reasonable dividend bill of health. Given its fairly significant leverage, however, dividend investors will want to keep an eye on its earnings and free cash flow stability to ensure that its dividend remains secure.
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