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 Frontier Communications (NYSE: FTR)and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio
Frontier Communications

12.5%

1.6

468.8%

64.7%
Windstream (NYSE: WIN)

8.4%

2.1

181.8%

99.2%
CenturyLink (NYSE: CTL)

8.4%

3.3

142.9%

40.1%
AT&T (NYSE: T)

5.9%

6.1

21.7%

129.8%

Source: S&P Capital IQ.

With an interest coverage of 1.6, Frontier Communications covers every $1 in interest expenses with just $1.6 in operating earnings. While its EPS payout ratio is an astronomical 468%, Frontier's earnings don't tell the whole story. Two years ago, Frontier made a game changing acquisition, buying Verizon's (NYSE: VZ) rural wireline assets. With this increase in assets Frontier's depreciation expense skyrocketed, while its actual cash outlays did not increase accordingly. The FCF payout ratio is the key here; it's only 64.7%. That's high, but not high enough to have the dividend at risk of being cut. The market, however, is certainly worrying that Frontier will need to cut its dividend.

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.