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' 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 Pfizer
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
---|---|---|---|---|
Pfizer |
3.9% |
10.2 |
70.2% |
31.7% |
AstraZeneca |
4.9% |
29.2 |
44.6% |
43.0% |
Teva Pharmaceutical |
1.9% |
15.3 |
22.1% |
34.0% |
Merck |
4.2% |
13.5 |
287.2% |
39.5% |
Source: Capital IQ, a division of Standard & Poor's.
With an interest coverage of 10.2, Pfizer covers every $1 in interest expenses with just over $10 in operating earnings. While its EPS payout ratio is 70%, Pfizer's FCF payout ratio is below 35%. You shouldn't have to worry that Pfizer 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 Pfizer to My Watchlist.
- Add AstraZeneca to My Watchlist.
- Add Teva Pharmaceutical to My Watchlist.
- Add Merck to My Watchlist.