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.
Vector yields a whopping 9.1%, 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.
Vector has a payout ratio of 164%.
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 Vector stacks up next to its peers:
|Vector Group||N/A||1.3 times|
Philip Morris International
Source: S&P Capital IQ. N/A = not applicable.
Vector doesn't have a debt-to-equity ratio because it has negative equity. Its operating income barely covers interest payments.
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, Vector's earnings per share have grown at an annual rate of 13%, while its dividend has grown at a 5% rate.
The Foolish bottom line
While a high yield in itself isn't always cause for alarm, and Vector has had reasonable growth over the past few years, its enormous payout ratio and debt burden are quite worrisome to me. To stay up to speed on Vector'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.