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.
Cisco yields 1.4%, not bad, but a bit less than the S&P 500's 2.2%.
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.
Cisco has a moderate payout ratio of 10%. This may seem modest, but it's important to remember that Cisco also spends a considerable amount (about ten times as much) on share buybacks.
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.
Cisco's debt-to-equity ratio is a fairly modest 36%. It has an interest coverage rate of 14 times.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
5-Year Earnings-per-Share Growth
5-Year Dividend Growth
Source: S&P Capital IQ. N/A = not applicable. *3-Year.
Cisco only began paying a dividend in March; as you can see, it's pretty rare for companies in its industry to pay dividends.
The Foolish bottom line
As a young dividend payer, Cisco exhibits a fairly strong dividend bill of health. It has a low payout ratio and a manageable debt burden. For now, the company has been opting to return money to shareholders -- and executives -- by buying back stock, so investors looking for a higher yield will want to keep an eye on those buybacks and how well the company is able to grow its earnings. To stay up to speed on Cisco's progress, or any other stock, add it to your stock watchlist. If you don't have one yet, you can create a free, personalized watchlist of your favorite stocks by clicking here.
Ilan Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter @TMFDada. The Motley Fool owns shares of Cisco Systems. Motley Fool newsletter services have recommended buying shares of Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.