Dividend investors know that it pays to follow how much of a company's money goes toward funding its payouts. 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 percentage of free cash flow devoted toward paying the dividend. Again, a ratio greater 80% could be a red flag.

Let's examine Bristol-Myers Squibb (NYSE: BMY) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio
Bristol-Myers Squibb

4.7%

44.7

67.4%

51.2%
GlaxoSmithKline (NYSE: GSK)

4.9%

11.7

186.0%

41.2%
Abbott Laboratories (NYSE: ABT)

3.7%

12.1

62.7%

41.3%
Novartis (NYSE: NVS)

3.2%

16.8

56.0%

78.1%

Source: Capital IQ, a division of Standard & Poor's.

With an interest coverage of 44.7, Bristol-Myers Squibb covers every $1 in interest expenses with just under $45 in operating earnings. Given that its EPS payout ratio and FCF payout ratio are below 70%, you shouldn't have to worry that Bristol-Myers Squibb will need to cut its dividend anytime soon. Even though the company is less than a year away from losing patent protection on its top-selling drug, Plavix, some analysts still believe the company will make a good long-term investment.

Another tool for better investing
Most investors don't keep tabs on their companies. That's a mistake. If you take the time to read past the headlines and crack a filing now and then, you're in a much better position to spot potential trouble early. We can help you keep tabs on your companies with My Watchlist, our free, personalized stock-tracking service.