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
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
---|---|---|---|---|
Integrys Energy Group |
5.4% |
3.7 |
72.5% |
85.6% |
Exelon |
5.1% |
5.6 |
56.0% |
152.5% |
Duke Energy |
5.3% |
3.6 |
93.4% |
NM |
Xcel Energy |
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
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 Integrys Energy Group to MyWatchlist.
- Add Exelon to MyWatchlist.
- Add Duke Energy to MyWatchlist.
- Add Xcel Energy to MyWatchlist.