By
Dan Dzombak
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More Articles
May 20, 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 one 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 percent of free cash flow devoted toward paying the dividend. Again, a ratio greater 80% could be a red flag.
Let's examine Timken (NYSE: TKR ) and three of its peers.
|
Company
|
Yield
|
Interest Coverage
|
EPS Payout Ratio
|
FCF Payout Ratio
|
| Timken |
1.6%
|
14.5
|
17.0%
|
54.9%
|
| United States Steel (NYSE: X ) |
0.4%
|
(0.9)
|
(7.0%)
|
(4.3%)
|
| Kaydon (NYSE: KDN ) |
2.0%
|
303.8
|
46.3%
|
55.3%
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| MSC Industrial Direct (NYSE: MSM ) |
1.3%
|
542.1
|
29.5%
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61.1%
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Source: Capital IQ, a division of Standard & Poor's.
With an interest coverage of 14.5, Timken covers every $1 in interest expenses with $14.5 in operating earnings. With its EPS payout ratio below 20% and FCF payout ratio below 55%, you shouldn't have to worry that Timken will need to cut its dividend anytime soon.
Another tool for better investing
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