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 Selective Insurance Group (Nasdaq: SIGI), which yields 2.9%.

Dividend
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.

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Selective Insurance Group Dividend Chart by YCharts

Selective Insurance Group raised its dividend in late 2007 from $0.12 to $0.13 per quarter, where it has remained since.

Immediate safety
To understand how safe a dividend is, we use two crucial tools, first:

  • 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.

Selective Insurance Group Times Interest Earned TTM Chart by YCharts

Selective Insurance Group covers every $1 in interest expense with just $2 in operating earnings. Investors should carefuly watch this number.

Sustainability
We use another tool to evaluate the safety of a dividend:

  • 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.

Sigipayoutratio

Source: S&P Capital IQ.

Selective Insurance Group's free cash flow payout ratio has been slowly rising the past 5 years but still remains low at 20%.

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 open 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.

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