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 than 80% could be a red flag.

Let's examine NSTAR (NYSE: NST) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

NSTAR

3.7%

3.9

49.4%

71.3%

Exelon (NYSE: EXC)

5%

5.6

56%

152.5%

DPL (NYSE: DPL)

4.4%

6.9

54.6%

67.5%

Progress Energy (NYSE: PGN)

5.2%

2.6

85.5%

NM

Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful due to negative FCF.

With an interest coverage ratio of 3.9, NSTAR covers every $1 in interest expenses with $3.90 in operating earnings. Given that its EPS payout ratio and FCF payout ratio are below 75%, you shouldn't have to worry that NSTAR 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 MyWatchlist, our free, personalized stock-tracking service.

Follow Dan Dzombak on Twitter at @DanDzombak to check out his musings and see what articles he finds interesting. Motley Fool newsletter services have recommended buying shares of and creating a covered strangle position on Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.