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 PepsiCo(NYSE: PEP) and three of its peers.



Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

PepsiCo 2.9% 10.7 51.4% 72.0%
Coca-Cola (NYSE: KO) 2.7% 12.1 34.5% 107.9%
Dr Pepper Snapple (NYSE: DPS) 3.0% 8.6 42.7% 31.9%
Starbucks (Nasdaq: SBUX) 1.4% 46.2 36.3% 54.9%

Source: Capital IQ, a division of Standard & Poor's.

With an interest coverage of 10.7, PepsiCo covers every $1 in interest expenses with almost $11 in operating earnings. Given that its EPS payout ratio is roughly 50% and its FCF payout ratio is below 75%, you shouldn't have to worry that PepsiCo 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.