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 Integrys Energy Group(NYSE: TEG) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

Integrys Energy Group

5.4%

3.7

72.5%

85.6%

Exelon (NYSE: EXC)

5.1%

5.6

56.0%

152.5%

Duke Energy (NYSE: DUK)

5.3%

3.6

93.4%

NM

Xcel Energy (NYSE: XEL)

4.3%

3.0

60.3%

NM

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

With an interest coverage ratio of 3.7, Integrys Energy Group covers every $1 in interest expenses with $3.70 in operating earnings. Given that its EPS payout ratio and FCF payout ratio are at high levels near 80%, you should monitor these ratios closely. If the ratios were to head closer to 100%, the dividend could be in danger of being cut; however, with a 70-year history of paying dividends, management probably knows what it's doing.

Another tool for better investing
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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 in 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.