Some dividends have staying power. Companies delivering enduring dividends tend to back their often-rising payouts with robust business and financial achievement.

Fragile dividends, meanwhile, result from weaker operational and financial characteristics. Those are the dividends to avoid. However, fragile dividends often tempt us because of high dividend yields.

How to tell the difference

Under the spotlight today, two FTSE 100 firms: international bank HSBC Holdings (LSE: HSBA) and mobile phone service provider Vodafone Group (LSE: VOD).

These firms operate in different sectors, but they both have a high dividend yield. At a recent share price of 507p HSBC Holdings’ forward yield for 2016 is around 6.7%. At 223p, Vodafone’s yield for the year to March 2017 is 5.1%.

Let’s run some tests to gauge business and financial quality, and score performance in each test out of a maximum five.

1. Dividend record

Both firms enjoy a decent record of ordinary dividends:

Ordinary dividends 2011 2012 2013 2014 2015
HSBC Holdings (cents) 41 45 49 50 51 (e)
Vodafone (pence) 8.9 9.52 10.19 11 11.22

Over four years HSBC Holdings’ dividend rose 24%. Vodafone’s increased by 26%.

For their dividend records, I’m scoring both firms 4/5.

2. Dividend cover

HSBC Holdings expects its 2016 adjusted earnings to cover its dividend around 1.5 times. Vodafone’s earnings look set to fall short of covering the forward dividend payout by around 50%.

However, cash pays dividends, so it’s worth digging deeper into how well, or poorly, both companies cover their dividend payouts with free cash flow, too. Last year, for example, Vodafone’s declared free cash flow failed to cover its dividend payments.

So , on dividend cover from earnings, I’m scoring HSBC Holdings 3/5 and Vodafone 0/5.  

3. Cash flow

Dividend cover from earnings means little if cash flow doesn’t support profits.

Here are the firms’ recent records on cash flow compared to profits:

  2010 2011 2012 2013 2014
HSBC Holdings          
Operating profit ($m) 16,520 18,608 17,092 20,240 16,148
Net cash from operations ($m) 55,742 79,762 (9,156) 44,977 (21,372)
Operating profit (£m) 537 6,224 (2,777) (4,191) 2,030
Net cash from operations (£m) 11,995 12,755 8,824 6,227 9,715

HSBC Holdings’ ability to generate cash from its operations fluctuates. However, cash flow in banking business is a less useful indicator of business health than it is at other types of business. Banks’ cash flows tend to be ‘noisy’, as we see here. Accounting quirks — such as how the banks classify their loans and investments, for example — can bolster or lower a cash-flow number artificially.

Vodafone’s cash performance is much steadier and the amounts of cash realised support declared profits well.

I’m scoring HSBC Holdings a benefit-of-the-doubt 3/5 and Vodafone 5/5.

4. Gross debt

Interest payments on borrowed money compete with dividend payments for incoming cash flow. That’s why big debts are undesirable in dividend-led investments.

Most banks carry big external debts and HSBC Holdings’ balance sheet entry for debt securities alone was almost six times the level of its operating profit in 2014. Vodafone’s borrowings run at around four times the level of cash generated annually from operations.

For their debt positions, both firms get 2/5.

5. Degree of cyclicality

HSBC Holdings’ share price moved from around 700p at the beginning of 2011 to 507p or so today, handing investors a 28% capital loss over the period, which is likely to have taken away any gains from dividend income.

Vodafone moved from around 170p at the start of 2011 to around 223p today, providing investors with a 31% capital gain.

HSBC Holdings’ share-price volatility results from cyclical effects, as we might expect with a bank.

I’m scoring HSBC Holdings a generous 2/5 and Vodafone 3/5 for its cyclicality.

Putting it all together

Here are the final scores for these firms:

  HSBC Vodafone
Dividend record 4 4
Dividend cover 3 0
Cash flow 3 5
Debt 2 2
Degree of cyclicality 2 3
Total score out of 25 14 14

Neither firm is perfect by these measures, which makes me cautious about selecting them as dividend-led investments.

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Overall, turnover has been growing at around 10% a year for this business, with profit growth not far behind. The firm has a decent record of rising dividends that looks set to continue, given its clearly identified path to growth. If the dividend keeps rising, share-price appreciation could follow.

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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.