Not all dividends are created equal. Here, we'll do a top-to-bottom analysis of a company to understand the quality of its dividend and see how that's changed over the past five years.
The company we're looking at today is Campbell Soup (NYSE: CPB ) , which yields 3.7%.
For more than 150 years,Campbell Soup has been the choice for millions of Americans. The company has a 60% market share in the U.S. wet-soup market, which translates into roughly 2 billion cans of soup every year. In recent times, strong competition from General Mills (NYSE: GIS ) , Kraft Foods (NYSE: KFT ) , and Heinz (NYSE: HNZ ) has eaten into sales and weighed on margins.
To evaluate the quality of a dividend, the first thing to consider is whether the company has paid a dividend consistently over the past five years, and, if so, how much has it grown.
Campbell Soup's dividend has been steadily rising since 2008.
To understand how safe a dividend is, we use three crucial tools, the first of which is:
- The interest coverage ratio, or the number of times interest is earned, which is calculated by 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. A ratio less than 1.5 is questionable; a number less than 1 means the company is not bringing in enough money to cover its interest expenses.
Campbell Soup has roughly $10 in operating earnings for every dollar of operating expense.
The other tools we use to evaluate the safety of a dividend are:
- 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's 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.
Source: S&P Capital IQ.
Campbell Soup's payout ratio has been stable the past two years.
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.
- Add Campbell Soup to My Watchlist.