Each time a company announces earnings, investors have an opportunity to gauge the health of the firm’s underlying business, assess its future prospects and evaluate the sustainability of its dividend.
In the real world, one size doesn’t fit all. Although we examine a wide range of performance measures, we always put what we see in the context of the individual company.
For example, payout ratios–dividends as a percentage of profits–provide insight into the safety of a firm’s payout.
However, investors can’t consider this metric in a vacuum. Businesses that generate a reliable stream of cash flow can comfortably pay out a much higher percentage of their earnings than companies in cyclical industries.
Debt levels likewise require context. Lifelong Income Portfolio holding Entergy Corp (NYSE: ETR) and other regulated utilities, for example, can finance their capital expenditures with 50 percent debt and 50 percent equity.
In contrast, a debt-to-capitalization ratio this high would pose significant risks for BHP Billiton (ASX: BHP, NYSE: BHP) and other companies whose earnings fluctuate with movements in commodity prices.
Investors must also pay attention to a company’s debt maturities. A capital structure that’s heavily weighted toward bonds maturing in 10 years or more entails much less exposure to interest rates than one that relies heavily on credit lines or faces significant near-term refinancing needs.