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 Limited Brands
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.
Limited yields 2.1%, a bit higher than the S&P 500's 1.9%.
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.
Limited 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 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.
Limited has a whopping debt-to-equity ratio of 691%, but its interest coverage rate is a reasonable 5.5 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, earnings per share have increased at an average annual rate of 10%, while its dividend has increased at a 6% rate.
The Foolish bottom line
So, is Limited a dividend dynamo? Perhaps. The company has a moderate yield, a modest payout ratio, and manageable debt. Dividend investors will want to keep an eye on how rapidly Limited is able to continue growing its earnings to ensure that it can comfortably increase its payouts over the coming years. If you're looking for some great dividend stocks, I also suggest you check out "Secure Your Future With 9 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 nine generous dividend payers -- simply click here.
