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 80% could be a red flag.
Let's examine 3M
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
---|---|---|---|---|
3M | 2.4% | 30.9 | 36.5% | 53.8% |
General Electric |
3.3% | 10.6 | 41.7% | 6.5% |
Emerson Electric |
2.7% | 14.4 | 43.8% | 48.5% |
Ingersoll-Rand |
1% | 4.9 | 17.1% | 134.1% |
Source: Capital IQ, a division of Standard & Poor's.
With an interest coverage of 30.9, 3M covers every $1 in interest expenses with more than $31 in operating earnings. And given its EPS payout ratio and FCF payout ratio below 55%, you shouldn't have to worry that 3M 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.
- Add 3M to MyWatchlist.
- Add General Electric to MyWatchlist.
- Add Emerson Electric to MyWatchlist.
- Add Ingersoll-Rand to MyWatchlist.