By
Dan Dzombak
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More Articles
June 27, 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.
Each of these ratios reflect dividends paid in the trailing 12 months, while yields are the expected forward yield. Let's examine Lancaster Colony (Nasdaq: LANC ) 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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Lancaster Colony
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2.2%
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N/A
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35.3%
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41.9%
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Campbell Soup (NYSE: CPB )
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3.4%
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10.8
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46.5%
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55.2%
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HJ Heinz (NYSE: HNZ )
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3.6%
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6.0
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58.8%
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75.3%
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ConAgra Foods (NYSE: CAG )
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3.7%
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7.9
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47.5%
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51.5%
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Source: Capital IQ, a division of Standard & Poor's.
Lancaster Colony does not have any debt, and as such it has no interest to cover. Given its EPS payout ratio and FCF payout ratio are below 45%, you shouldn't have to worry that Lancaster Colony will need to cut its dividend anytime soon.
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.
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