By
Dan Dzombak
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More Articles
May 25, 2011
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As a dividend investor, it pays to follow how much of a company's money goes toward funding its dividend. A nice yield now won't matter much if the company can't keep making those payments going forward.
Here, we'll highlight a given company and its closest competitors to see just how safe their dividends are, with a little help from three crucial tools:
- The interest coverage ratio, or earnings before interest and taxes, divided by interest expense. The interest coverage ratio measures a company's ability to pay the interest on its debt. An interest coverage ratio less than 1.5 is questionable; a number less than 1 means that the company is not bringing in enough money to cover its interest expenses.
- The EPS payout ratio, or dividends per share divided by earnings per share. The EPS payout ratio measures the percentage of earnings that go toward paying the dividend. A ratio greater than 80% is worrisome.
- The FCF payout ratio, or dividends per share divided by free cash flow per share. Earnings alone don't always paint a complete picture of a business' health. The FCF payout ratio measures the percent of free cash flow devoted toward paying the dividend. Again, a ratio greater than 80% could be a red flag.
Let's examine Nalco (NYSE: NLC ) and three of its peers.
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Company
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Yield
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Interest Coverage
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EPS Payout Ratio
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FCF Payout Ratio
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Nalco
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0.5%
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2.6
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6.8%
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10.2%
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General Electric (NYSE: GE )
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3.1%
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12.6
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41.7%
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6.3%
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Dow Chemical (NYSE: DOW )
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2.8%
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2.7
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32.4%
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93.2%
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DuPont (NYSE: DD )
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3.2%
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7.1
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45.9%
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NM
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Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful due to negative FCF.
With an interest coverage ratio of 2.6, Nalco covers every $1 in interest expenses with $2.60 in operating earnings. Given its EPS payout ratio and FCF payout ratio are around 10%, you shouldn't have to worry that Nalco will need to cut its dividend anytime soon.
Another tool for better investing
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