Cliffs Natural Resources: Dividend Dynamo or the Next Blowup?

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 Cliffs Natural Resources (NYSE: CLF  ) stacks up. In this series, we consider four critical factors investors should examine in every dividend stock. We'll then tie it all together to look at whether Cliffs is a dividend dynamo or a disaster in the making.

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.

Cliffs yields 3.6%, considerably 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.

Cliffs has a modest payout ratio of 21%.

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.

Cliffs has a debt-to-equity ratio of 56% and an interest coverage rate of 11 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, Cliffs's earnings per share have surged at an average annual rate of 35%, while its quarterly dividend has increased from $0.05 to $0.28.

The Foolish bottom line
So is Cliffs a dividend dynamo? It could very well be. It has a high yield and a history of massive earnings growth. While I don't claim to have a crystal ball that predicts commodity prices, with a modest payout ratio and reasonable debt levels, the company should be able to maintain its elevated payouts even if earnings were to decline a bit due to price fluctuations.

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