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.
Let's examine how Johnson & Johnson
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.
Johnson & Johnson yields a generous 3.5%, quite a bit higher than the S&P 500 2.1%.
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.
Johnson & Johnson has a moderate payout ratio of 53%.
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.
Johnson & Johnson has a debt-to-equity ratio of just 30% and an interest coverage rate of 31 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.
Over the past five years, Johnson & Johnson has grown its earnings per share at an average annual rate of 2%, while its dividend has grown at a 10% rate.
The Foolish bottom line
Johnson & Johnson exhibits a clean dividend bill of health. It has a fairly generous yield that appears affordable given the company's moderate payout ratio. Debt isn't a problem. Dividend investors, however, will want to keep an eye on the company's earnings growth to ensure that it's able to continue raising its payouts in the future.
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Ilan Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter, where he goes by @TMFDada. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services have recommended buying shares of and creating a diagonal call position in Johnson & Johnson. 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.