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 R.R. Donnelley
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.
R.R. Donnelley yields a massive 8.7%, considerably higher than the S&P 500's 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.
R.R. Donnelley has a payout ratio of 91%, though that figure falls quite a bit, to 45%, on a free cash flow basis.
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 see how R.R. Donnelley stacks up next to its competitors:
|R.R. Donnelley||216%||3 times|
|Avery Dennison||71%||5 times|
Source: S&P Capital IQ.
Publishing is a rather capital-intensive business -- hence the high debt-to-equity ratios and low interest coverage rates. McGraw-Hill has a higher interest coverage rate because it generates substantial revenue from its Standard & Poor's division.
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 Annual Earnings-per-Share Growth
5-Year Annual Dividend-per-Share Growth
Source: S&P Capital IQ. *Quad Graphics began paying a common dividend in early 2011.
Despite the highly publicized difficulties facing the publishing industry that the rise of the Internet has presented, Quad/Graphics and McGraw-Hill have managed to hang on to their profits in recent years. R.R. Donnelley had a few years of losses, but it's returned to profitability recently in spite of restructuring charges. Avery Dennison hasn't fared as well as the other three, though profits may not be as bad as they look, as recent earnings were affected by restructuring charges.
The Foolish bottom line
With a high yield and a reasonable free cash flow payout ratio, R.R. Donnelley could be a dividend dynamo despite its considerable debt burden -- but only if it's able to retain or even continue growing its earnings in the face of pressures on the publishing industry over the coming years. If you're looking for some great dividend stocks, I suggest you check out "Secure Your Future With 11 Rock-Solid Dividend Stocks," a special report from The Motley Fool about some serious dividend dynamos. I invite you to grab a free copy to discover everything you need to know about these 11 generous dividend payers -- simply click here.
Ilan Moscovitz doesn't own shares of any company mentioned. 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.