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 Cooper Industries (NYSE: CBE), which yields 2%.

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.

CBE Dividend Chart

CBE Dividend data by YCharts.

Cooper Industries has raised its dividend every year since 2009 to where it now sits at $0.31 per quarter.

Immediate safety
To understand how safe a dividend is, we use two 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 one means the company is not bringing in enough money to cover its interest expenses.

CBE Times Interest Earned TTM Chart

CBE Times Interest Earned TTM data by YCharts.

At 13, Cooper Industries covers every $1 in interest expense with $13 in operating earnings.

Sustainability
The other tool we use to evaluate the safety of a dividend is:

  • 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.

Source: S&P Capital IQ.

Cooper Industries' payout ratio rose slightly after the financial crisis but has since come back down to the very low level of around 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 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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