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 Frontier
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.
Frontier yields a whopping 9.1% -- considerably higher than the S&P 500's 1.7%.
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.
Frontier' payout ratio is 387%, but that figure drops to a much more reasonable 71% when we look at it on a free cash flow basis.
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 Frontier stacks up next to its peers:
|
Company |
Debt-to-Equity Ratio |
Interest Coverage |
|---|---|---|
|
Frontier |
163% |
2 times |
|
AT&T |
58% |
6 times |
|
Verizon |
69% |
7 times |
|
Sprint Nextel |
131% |
N/A* |
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, Frontier's free cash flow has increased by 21% annually, while its dividend has shrunk at a rate of 4% .
The Foolish bottom line
Frontier exhibits a fairly reasonable dividend bill of health. It has an enormous yield, a moderately high free cash flow payout ratio, and free cash flow growth. Given the company's significant leverage, however, dividend investors will want to watch to make sure that they are confident in the company's cash flow stability.
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