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 RadioShack
|
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
|---|---|---|---|---|
| RadioShack |
1.9% |
8.6 |
15.3% |
12.4% |
|
Wal-Mart Stores |
2.7% |
11.4 |
27.8% |
55.5% |
|
Best Buy |
2.1% |
26.9 |
19.2% |
72.6% |
|
Target |
2.1% |
7.0 |
24.4% |
19.1% |
Source: Capital IQ, a division of Standard & Poor's.
With an interest coverage of 8.6, RadioShack covers every $1 in interest expenses with more than $8 in operating earnings. Given that its EPS payout ratio and FCF payout ratio are below 20%, you shouldn't have to worry that RadioShack will need to cut its dividend anytime soon. As a whole, the company has been doing OK, but some analysts are wondering whether RadioShack is a sell.
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 RadioShack to MyWatchlist.
- Add Wal-Mart Stores to MyWatchlist.
- Add Best Buy to MyWatchlist.
- Add Target to MyWatchlist.
Follow Dan Dzombak on Twitter at @DanDzombak to check out his musings and see what articles he finds interesting. The Motley Fool owns shares of Best Buy, RadioShack, and Wal-Mart Stores. Motley Fool newsletter services have recommended buying shares of Best Buy and Wal-Mart Stores and creating a diagonal call position in Wal-Mart Stores. 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.
