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 one 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's 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 Hewlett-Packard (NYSE: HPQ) and three of its peers.
|
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
|---|---|---|---|---|
| Hewlett-Packard |
1.3% |
44.5 |
7.9% |
9.5% |
| Cisco Systems (Nasdaq: CSCO) |
1.5% |
13.7 |
18.8% |
6.2% |
| Seagate Technology (Nasdaq: STX) |
4.3% |
5.2 |
44.8% |
NM |
| Intel (Nasdaq: INTC) |
3.7% |
2716.3 |
30.6% |
47.7% |
Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful because of negative FCF.
With an interest coverage ratio of 44.5, Hewlett-Packard covers every $1 in interest expenses with more than $44 in operating earnings. Given that its EPS payout ratio and FCF payout ratio are below 10%, you shouldn't have to worry that Hewlett-Packard 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.
- Add Hewlett-Packard to My Watchlist.
- Add Cisco Systems to My Watchlist.
- Add Seagate Technology to My Watchlist.
- Add Intel to My Watchlist.
