Dividend investors know that it pays to follow how much of a company's money goes toward funding its payouts. 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 percentage of free cash flow devoted toward paying the dividend. Again, a ratio greater than 80% could be a red flag.

Each of these ratios reflect dividends paid in the trailing 12 months; yields are the expected forward yield. Let's examine Altria Group (NYSE: MO) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio
Altria Group 6% 5.7 92.7% 68.3%
Philip Morris International (NYSE: PM) 4.7% 14.3 13.5% NA
Lorillard (NYSE: LO) 4.6% 17.0 66.3% 57.7%
British American Tobacco (AMEX: BTI) 4.1% 9.0 73.2% 71.4%

Source: S&P Capital IQ.

With an interest coverage of 5.7, Altria covers every $1 in interest expenses with almost $6 in operating earnings. While its EPS payout ratio is a high 92.7%, Altria's FCF payout ratio is below 70%. As such, you shouldn't have to worry that Altria will need to cut its dividend anytime soon.

Another tool for better investing
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