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 1 means that the company is not bringing in enough money to cover its interest expenses.
- 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' 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 United Technologies
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
---|---|---|---|---|
United Technologies |
2.3% |
10.9 |
34.6% |
26.1% |
Lockheed Martin |
3.9% |
11.4 |
34.2% |
34.9% |
Northrop Grumman |
3.2% |
12.2 |
26.6% |
21.7% |
General Dynamics |
2.7% |
25.4 |
25% |
22.8% |
Source: Capital IQ, a division of Standard & Poor's.
With an interest coverage of 10.9, United Technologies covers every $1 in interest expenses with nearly $11 in operating earnings. Given its EPS payout ratio and FCF payout ratio are below 35%, you shouldn't have to worry that United Technologies will need to cut its dividend anytime soon. On the whole, the company has been doing well, achieving a notably high ROIC, but doesn't look particularly cheap.
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 MyWatchlist, our free, personalized stock-tracking service.
- Add United Technologies to MyWatchlist.
- Add Lockheed Martin to MyWatchlist.
- Add Northrop Grumman to MyWatchlist.
- Add General Dynamics to MyWatchlist.