By
Dan Dzombak
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More Articles
October 29, 2011
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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 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 than 80% could be a red flag.
Each of these ratios reflect dividends paid in the trailing 12 months; yields are the expected forward yield. Let's examine Apache (NYSE: APA ) and three of its peers.
|
Company
|
Yield
|
Interest Coverage
|
EPS Payout Ratio
|
FCF Payout Ratio
|
| Apache |
0.6% |
32.4 |
6% |
10% |
| Chesapeake Energy (NYSE: CHK ) |
1.2% |
72.3 |
20.8% |
NM |
| EOG Resources (NYSE: EOG ) |
0.7% |
3.3 |
39.6% |
NM |
| Devon Energy (NYSE: DVN ) |
1% |
10.9 |
4.8% |
NM |
Source: S&P Capital IQ. NM = not meaningful.
With an interest coverage of 32.4, Apache covers every $1 in interest expenses with $32 in operating earnings. Given that its EPS payout ratio and FCF payout ratio are at or below 10%, you shouldn't have to worry that Apache will need to cut its dividend anytime soon.
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