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 Fifth Third Bancorp
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.
Fifth Third Bancorp yields 2.4%, a bit 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.
Fifth Third Bancorp has a modest payout ratio of 24%.
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 Tier 1 capital ratio is a commonly used leverage metric for banks that compares equity and reserves with total risk-weighted assets. In a nonfinancial crisis, a ratio above 13% is generally considered to be relatively conservative.
Fifth Third Bancorp has a Tier 1 capital ratio of 11.9%, and credit quality has been improving rapidly over the past couple of years.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Earnings plunged during the U.S. financial crisis, leading to major losses in 2008. Since then, the bank has recovered its profitability quite a bit, though not to its pre-crisis levels. All told, over the past five years, Fifth Third Bancorp's earnings per share shrunk at an average annual rate of 11%, while its quarterly dividend has fallen from $0.44 at its height in 2008 to $0.01 during the crisis, before rising to $0.08 today.
The Foolish bottom line
So, is Fifth Third Bancorp a dividend dynamo? Not exactly. Its earnings and dividend are still in recovery mode, and like many banks today, its yield may be moderate, but it's not huge. That said, the recovering bank exhibits a fairly healthy dividend with its modest payout ratio and improving credit quality. 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. The Motley Fool owns shares of Fifth Third Bancorp. 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.