Dividend investors know that it pays to follow how much of a company's money goes toward funding its payouts. 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 percentage of free cash flow devoted toward paying the dividend. Again, a ratio greater 80% could be a red flag.

Let's examine Quaker Chemical (NYSE: KWR) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio
Quaker Chemical

2.3%

10.5

33.0%

91.3%
Chase (AMEX: CCF)

2.1%

49.2

24.4%

22.6%
RPM International (NYSE: RPM)

3.6%

5.3

60.1%

44.4%
Huntsman (NYSE: HUN)

2.1%

2.6

36.4%

NM

Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful because of negative free cash flow.

With an interest coverage of 10.5, Quaker Chemical covers every $1 in interest expenses with $10.50 in operating earnings. Although its EPS payout ratio is below 35%, investors should keep a careful eye on its FCF payout ratio, which stands at 91.3%.

Another tool for better investing
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