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.
AK Steel yields 2.4%, a bit better 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.
AK Steel doesn't have a payout ratio because its earnings took a loss over the past year.
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 AK Steel stacks up next to its peers:
|AK Steel||153%||0.5 time|
United States Steel
Source: S&P Capital IQ.
The steel industry tends to employ a decent amount of leverage. As demand for steel has declined during the economic slowdown, operating earnings have fallen, pushing interest coverage down.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Despite negative earnings, AK Steel has held its annual dividend at $0.20 since it was reinstated in 2008.
The Foolish bottom line
AK Steel exhibits a troubling dividend bill of health. The company may be able to continue paying out its dividend until earnings pick up again by borrowing money, liquidating cash or other assets, or selling shares, but ultimately that's unsustainable. Dividend investors interested in AK Steel should keep their eyes on when the company will be able to return to profitability. To stay up to speed on AK Steel'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.
Ilan Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter @TMFDada. Motley Fool newsletter services have recommended buying shares of Nucor. 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.