By
Dan Dzombak
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More Articles
October 26, 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 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's health. The FCF payout ratio measures the percent of free cash flow devoted toward paying the dividend. Again, a ratio greater than 80% could be a red flag.
Each of these ratios reflects dividends paid in the trailing 12 months, while yields are the expected forward yield. Let's examine CVS Caremark (NYSE: CVS ) and three of its peers.
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Company
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Yield
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Interest Coverage
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EPS Payout Ratio
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FCF Payout Ratio
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CVS Caremark
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1.4%
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10.9
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17.3%
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13.4%
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Walgreen (NYSE: WAG )
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2.7%
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55.4
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25.5%
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29.2%
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Omnicare (NYSE: OCR )
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0.6%
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2.9
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(36.1%)
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0.7%
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Aetna (NYSE: AET )
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1.6%
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11.7
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7.4%
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4.3%
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Source: S&P Capital IQ.
With an interest coverage of 10.9, CVS Caremark covers every $1 in interest expenses with almost $11 in operating earnings. Given that its EPS payout ratio and FCF payout ratio are below 20%, you shouldn't have to worry that CVS Caremark will need to cut its dividend anytime soon.
Another tool for better investing
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