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.
Southern yields a solid 4.5%, considerably higher than the S&P's 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.
Southern has a payout ratio of 77%.
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 Southern stacks up next to its peers:
|Southern Company||115%||4 times|
Source: S&P Capital IQ.
Southern has a moderately high debt burden, though it's important to keep in mind that electric utilities is a capital-intensive yet stable industry that often uses lots of debt.
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, Southern Company's earnings per share and dividend per share have both grown at an annual rate of 4%.
The Foolish bottom line
Southern exhibits a clean dividend bill of health. It has a big yield, a reasonable payout ratio, a manageable burden, and a bit of growth. Given its relatively high payout ratio, dividend investors looking for growth should look for continued earnings growth to ensure that the company can afford even bigger payouts in the future. To stay up to speed on Southern Company's progress, 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.