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 ITT (NYSE: ITT) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

ITT 1.7% 13.3 24.0% 31.0%
Raytheon (NYSE: RTN) 3.5% 18.3 33.0% 35.0%
General Dynamics (NYSE: GD) 2.5% 25.4 25.0% 22.8%
Northrop Grumman (NYSE: NOC) 3.1% 12.2 26.6% 21.7%

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

With an interest coverage of 13.3, ITT covers every $1 in interest expenses with $13 in operating earnings. Given its EPS payout ratio and FCF payout ratio are below 35%, you shouldn't have to worry that ITT will need to cut its dividend anytime soon.

Another tool for better investing
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