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' health. The FCF payout ratio measures the percent of free cash flow devoted toward paying the dividend. Again, a ratio greater 80% could be a red flag.
Let's examine KLA-Tencor
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
---|---|---|---|---|
KLA-Tencor |
2.3% |
14.7 |
23.1% |
47.7% |
Linear Technology |
2.8% |
12.9 |
39.4% |
60.6% |
Cognex |
1.1% |
NM |
17.4% |
23.9% |
Applied Materials |
2.2% |
110.9 |
27.5% |
23.0% |
Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful; Cognex had no interest expense during the period.
With an in terest coverage of 14.7, KLA-Tencor covers every $1 in interest expenses with $14.70 in operating earnings. And given its EPS payout ratio and FCF payout ratio are below 50%, you shouldn't have to worry that KLA-Tencor will need to cut its dividend anytime soon.
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.
- Add KLA-Tencor to My Watchlist.
- Add Linear Technology to My Watchlist.
- Add Cognex to My Watchlist.
- Add Applied Materials to My Watchlist.