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 Stanley Black & Decker (NYSE: SWK) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

Stanley Black & Decker

2.4%

8.1

51.4%

26.2%
Fortune Brands (NYSE: FO)

1.2%

4.0

23.7%

41.4%
Snap-on (NYSE: SNA)

2.1%

6.6

35.2%

611.1%
Jarden (NYSE: JAH)

1%

3.2

16.2%

-16.1%

Source: Capital IQ, a division of Standard & Poor's.

With an interest coverage of 8.1, Stanley Black & Decker covers every $1 in interest expenses with over $8 in operating earnings. While its EPS payout ratio is over 50%, Stanley Black & Decker's FCF payout ratio is a low 26.2%. As such you shouldn't have to worry that Stanley Black & Decker will need to cut its dividend anytime soon.

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.