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 Leggett & Platt
1. Yield
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.
Leggett & Platt yields 5%, 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.
Leggett & Platt's payout ratio is a massive 102%, but the company tends to generate considerably more free cash flow than net income. On a free cash flow basis, the payout ratio falls to 61%.
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.
Leggett & Platt has a moderate debt-to-equity ratio of 66% and an interest coverage rate of seven times.
4. Growth
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, Leggett & Platt's earnings per share have shrunk at an average annual rate of 4% while its dividend has grown at a 10% rate.
The Foolish bottom line
Is Leggett & Platt a dividend dynamo? Not quite. Although the company has a high yield, a moderate free cash flow payout ratio, and manageable debt, it hasn't been able to consistently produce earnings growth over the past few years. Dividend investors will want to keep an eye on its earnings growth to see if that's able to turn around as the economy recovers, so that the company can maintain and grow its dividend for years to come. If you're looking for some solid 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.
