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 Terra Nitrogen (NYSE: TNH) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio
Terra Nitrogen

15.4%

962.7

64.5%

64.4%
Mosaic (NYSE: MOS)

0.3%

54.3

4.0%

7.3%
Potash Corp. (NYSE: POT)

0.5%

23.5

7.3%

38.4%
Scotts Miracle-Gro (NYSE: SMG)

1.9%

8.8

23.6%

17.8%

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

With an interest coverage of 962.7, Terra Nitrogen covers every $1 in interest expenses with over $900 in operating earnings, meaning the company barely has any debt at all. Given that its EPS payout ratio and FCF payout ratio are below 70%, you shouldn't have to worry that Terra Nitrogen will need to cut its dividend anytime soon.

Another tool for better investing
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