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.
First and foremost, dividend investors like a large 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, which would drive up the share price and shrink the yield.
Waste Management yields 3.7% — moderate but certainly not cause for alarm.
2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company pays out in dividends to the amount it generates. 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.
Waste Management’s payout ratio is a whopping 64%. On a free cash flow basis, the payout is 50%.
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.
Let’s examine how Waste Management stacks up next to its peers:
|Republic Services (NYSE: RSG )||
|Stericycle (Nasdaq: SRCL )||
|Waste Connections (NYSE: WCN )||
Source: Capital IQ, a division of Standard & Poor’s.
Waste Management carries a fairly significant amount of leverage.
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 three years, Waste Management’s earnings have shrunk at an annual rate of 2%, while its dividend has grown at a rate of 9%.
The Foolish bottom line
Waste Management exhibits a decent dividend bill of health. The stability and growth of its earnings will be important to watch given the company’s significant leverage.
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