Not all dividends are created equal. Here, we'll do a top-to-bottom analysis of a given company to understand the quality of its dividend and how that's changed over the past five years.
The company we're looking at today is Walter Energy (NYSE: WLT ) , which yields 0.7%.
Industry
Walter Energy is a producer of met coal for the steel industry. The company -- along with competitors Patriot Coal (NYSE: PCX ) and Alpha Natural Resources (NYSE: ANR ) -- have been hurt as customers have slowed down orders of coal. Walter's stock price has jumped around lately as some U.K. newspapers have speculated that BHP Billiton (NYSE: BHP ) was considering acquiring the company.
Dividend
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.
Walter Energy's dividend has sharply and steadily risen since 2008, and is now $0.13 per quarter.
Immediate safety
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.
At 8.41, Walter Energy covers every $1 in interest expense with more than $8 in operating earnings.
Sustainability
The other tools we use to evaluate how safe a dividend is 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.
Walter Energy's payout ratio has been consistently below 20%.
Alternatives
Source: S&P Capital IQ.
With a low yield, there are alternatives in the industry. Alliance Resource Partners (Nasdaq: ARLP ) has a 5.3% yield and nearly a 50% payout ratio. Arch Coal (NYSE: ACI ) has a yield nearly four times higher than Walter Energy's at 2.8% and a payout ratio of just double. Cliffs Natural Resources (NYSE: CLF ) rounds out the group with a dividend yield of 1.6% and a payout ratio of just 6%.
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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