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 Energy Transfer Partners (NYSE: ETP ) , which yields 7.9%.
Industry
Energy Transfer Partners includes pipelines and other midstream operations. The company, like peer Kinder Morgan (NYSE: KMP ) , has been a steady performer as its operations are largely unaffected by the movements of oil and natural gas prices. The company also has a retail propane operation, similar to Suburban Propane Partners (NYSE: SPH ) .
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 it has grown.
With its steady business, Energy Transfer Partners has a steady quarterly dividend of $0.89.
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 one means the company is not bringing in enough money to cover its interest expenses.
Energy Transfer Partners covers every $1 in interest expense with more than $7 in operating earnings.
Sustainability
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.
Energy Transfer Partners' payout ratio has been steadily rising as its issued shares expand while its dividend stays the same.
Alternatives
Source: S&P Capital IQ.
There are some alternatives in the industry. Farrellgas Partners (NYSE: FGP ) has a yield of 10.3% but a negative payout ratio. Linn Energy (Nasdaq: LINE ) has a yield of 7.4% and a payout ratio of 118%. Enterprise Products Partners (NYSE: EPD ) rounds out the group with a yield of 5.5%.
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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