Not all dividends are created equal. Here, we'll do a top-to-bottom analysis of a given company to understand the quality of its dividend and how that's changed over the past five years.
The company we're looking at today is Nordic American Tankers (NYSE: NAT ) , which yields 9.8%.
Nordic American Tankers is a shipping company that focuses on oil tankers. The tanker market had been stabler than other shipping markets, which have greatly hurt some companies such as DryShips (Nasdaq: DRYS ) , but weakness this year has been hurting all tanker companies. Teekay (NYSE: TK ) and Overseas Shipping Group (NYSE: OSG ) have been hurting, while some think Frontline (NYSE: FRO ) is on the brink of death.
To evaluate the quality of a dividend, the first thing to consider is whether the company has paid a dividend consistently over the past five years, and, if so, how much has it grown.
Nordic American's dividend has been declining as the tanker shipping market has weakened.
To understand how safe a dividend is, we use three crucial tools, the first of which is:
- The interest coverage ratio, or the number of times interest is earned, which is calculated by 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. A ratio less than 1.5 is questionable; a number less than 1 means the company is not bringing in enough money to cover its interest expenses.
Nordic American doesn't cover its interest expense with operating earnings, which is worrisome. However, because of large depreciation expenses on a cash basis, Nordic American is able to cover its dividend.
The other tools we use to evaluate the safety of a dividend are:
- 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.
Source: S&P Capital IQ.
Nordic American's payout ratio has been all over the place.
Another tool for better investing
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