How safe is South32's dividend?

Given the uncertain economic outlook, it is difficult to assess whether previous dividend forecasts are still useful. Yet, dividend payouts are a vital part of the return that investors get from owning stocks over time, and investors are not wrong to be looking out for stocks that can reliably pay a strong dividend.

Beyond providing income, dividends are also a signal that a company is well-financed and well-managed. Today I'm going to use South32 (ASX:S32) as of what to look for when it comes to dividend data.

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Rules for finding reliable dividend payers

1. Dividend safety

Attractively high yields obviously turn heads - but it’s important to know that a dividend is affordable, especially in times where there is a need to save cash. Dividend Cover (similar to the payout ratio) is a go-to measure of a company's net income over the dividend paid to shareholders. It’s calculated as earnings per share divided by the dividend per share and helps to indicate how sustainable a dividend is.

Dividend cover of less than 1x suggests that the company can’t fund the payout from its current year earnings - and might be relying on other sources of funds to pay it.

• South32 has dividend cover of 2.19.

2. High (but not excessive) dividend yield

Dividend yield is an important financial measure because it tells you the percentage of how much a company pays out in dividends each year relative to its share price. That makes it easy to compare dividend payouts right across the market, and against its competitors.

High yields are obviously appealing – but be careful of excessively high yields because they can be a sign of underlying problems. When the market suspects a company may be unable to sustain its dividend, the share price will fall, which pushes the yield higher. As a rule of thumb, a dividend yield of 10% or greater is a signal that a dividend may be too good to be true.

• South32 has a dividend yield of 8.82%.

3. Dividend growth

Another important marker in assessing the reliability of a dividend is a track record of dividend growth - which can usually be used as evidence that the growth will continue. Consistent dividend growth can be a pointer to companies that are carefully managing their payout policies - and rewarding their shareholders over time. Rather than aggressively dishing out earnings, dividend growth companies tend to have more modest yields, but are better at sustaining their payouts.

• South32 has increased its dividend payout 3 times over the past 10 years - and the dividend per share is forecast to grow by 420.5% in the coming year.

What does this mean for potential investors?

Yield, Growth and Safety are the three main pillars that support some of the most popular dividend investing strategies. But it's important to know that dividend payouts can be cut or cancelled very quickly when the outlook changes.

To get a fuller understanding of the dividend prospects for any stock, it's important to do some investigation yourself. Indeed, we've identified areas of concern with South32 that you can find out about here.