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 Avon
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.
Avon yields 4.8%, considerably higher than the S&P 500'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.
Avon has a moderately large payout ratio of 79%, and that figure expands to 106% if you look at it on a free cash flow basis that takes into account all the new investments Avon is making in its facilities.
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.
Avon has a substantial debt-to-equity ratio of 209%, though its interest coverage is a sizable 12 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, Avon's earnings per share have only grown at an average annual rate of 3%, while its dividend has grown at a 6% rate.
The Foolish bottom line
So, is Avon a dividend dynamo? It's a mixed picture, but probably not. The company does have a high yield and reasonable interest coverage rate. Dividend investors will want to keep an eye on its fairly large debt-to-equity ratio, straining payout ratio, and, in recent years, muted growth (earnings are actually below their 2007 levels) to see if this high-yielder can reach full dividend dynamo status. 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.