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.
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.
Duke yields 5.3%, considerably higher than the S&P's 1.8%
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.
Duke's payout ratio is 94%.
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 5 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 Duke stacks up next to its peers:
|Duke Energy||81%||4 times|
Source: Capital IQ, a division of Standard & Poor's.
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, Duke's earnings per share have declined by an annual rate of 12%, though that's mostly due to impairment charges it took on goodwill. Earnings excluding unusual items actually improved rather substantially over that time frame. Over the same time period, Duke's dividend shrunk at a 4% rate.
The Foolish bottom line
Duke exhibits a somewhat reasonable dividend bill of health. It has a moderately low level of debt relative to its peers and has had some success growing earnings. Dividend investors will want to keep an eye on whether that earnings growth continues so that Duke's payout ratio can contract.
Ilan Moscovitz doesn't own shares of any companies mentioned. You can follow him on Twitter at @TMFDada. Motley Fool newsletter services have recommended buying shares of Dominion Resources and Exelon and creating a covered strangle position in Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.