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 Teekay Tankers (NYSE: TNK), which yields 16.7%.

Industry
Teekay Tankers is a shipping company that focuses on oil tankers. The tanker market had been stabler than other shipping markets, which have greatly hurt companies such as DryShips (Nasdaq: DRYS), but weakness this year has been hurting all tanker companies. Competitors Overseas Shipping Group and Ship Finance International (NYSE: SFL) have been hurting, while some think Frontline (NYSE: FRO) is on the brink of death.

Teekay Tankers Total Return Price Chart

Teekay Tankers Total Return Price Chart by YCharts

Dividend
To evaluate the quality of a dividend, the first thing to consider is, has the company paid a dividend consistently over the past five years and if so, how much has it grown.

Teekay Tankers Dividend Chart

Teekay Tankers Dividend Chart by YCharts

Teekay's dividend has tracked the strength and weakness of the industry, and has been declining since 2010.

 Immediate safety 
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. 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. 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.

Teekay Tankers Times Interest Earned TTM Chart

Teekay Tankers Times Interest Earned TTM Chart by YCharts

Teekay covers every $1 in interest expense with $16 in operating earnings.

Sustainability
The other tools we use to evaluate how safe a dividend is 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.

Dantnkpayoutratio

Source: S&P Capital IQ.

Teekay Tankers distributes the majority of its cash flow to shareholders, and, as such, its payout ratio is consistently high.

Alternatives

Dantnkpayoutratiovsyield

Source: S&P Capital IQ

There are some alternatives out there in the industry. Nordic American Tankers (NYSE: NAT) has a similar policy of paying out the majority of its cash flow, sporting a yield of 9.9%. DHT (NYSE: DHT) has the same yield as Teekay Tankers, while Golar LNG (Nasdaq: GLNG) rounds out the list with a yield of 2.8%. All three have negative free cash flow, which is why they show up at the bottom of the graph above.

Another tool for better investing
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