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 Weight Watchers International (NYSE: WTW) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

Weight Watchers International 0.8% 5.7 23.5% 15.1%
NutriSystem (Nasdaq: NTRI) 4.9% 126.9 80.5% 176.6%
Kraft Foods (NYSE: KFT) 3.3% 4.0 67.3% 246.1%
Hormel Foods (NYSE: HRL) 1.7% 26.3 27.6% 32.4%

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

With an interest coverage of 5.7, Weight Watchers covers every $1 in interest expenses with $5.70 in operating earnings. Given its EPS payout ratio and FCF payout ratios are below 25%, you shouldn't have to worry that Weight Watchers 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.