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 Windstream
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.
Windstream yields a whopping 8.3%, considerably higher than the S&P'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.
Windstream has an enormous payout ratio of 296%. But it's common in the telecommunications industry for companies to generate superior free cash flow to net income. On a free cash flow basis, its payout ratio falls to 97%. That's still a tight position, due in large part to higher capital expenditures this year, but the situation isn't as absurd as the net income payout ratio would have us think.
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.
Windstream has a debt-to-equity ratio of 619% and an interest coverage rate of two times. That seems a bit severe, but it's also in line with its peers. After all, broadband is a capital intensive business. Management says it is trying to deleverage somewhat.
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, Windstream's earnings per share have shrunk at an annual rate of 20%. Adjusted free cash flow has basically fallen by half. Meanwhile, quarterly dividends have held steady at $0.25.
The Foolish bottom line
So, is Windstream a dividend dynamo or a blowup? Windstream exhibits a somewhat mixed dividend bill of health. It has an enormously tempting yield, but it does pays out a significant portion of its profits in dividends, is significantly leveraged, and has had difficulty maintaining profits over the past few years. Dividend investors will want to keep an eye on whether Windstream is able to stabilize and grow its earnings in the next couple of years, as analysts predict, so that it can more comfortably support its high payouts.
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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.