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 Dow Chemical (NYSE: DOW) and three of its peers.
|
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
|---|---|---|---|---|
| Dow Chemical | 2.8% | 2.7 | 32.4% | 93.2% |
| DuPont (NYSE: DD) | 3.3% | 7.1 | 45.8% | (297.8%) |
| Monsanto (NYSE: MON) | 1.6% | 13.1 | 47.8% | 35.6% |
| PPG Industries (NYSE: PPG) | 2.7% | 7.7 | 37.4% | 42.0% |
Source: Capital IQ, a division of Standard & Poor's.
With an interest coverage of 2.7, Dow Chemical covers every $1 in interest expenses with just under $3 in operating earnings. Although the company's EPS payout ratio is below 35%, its FCF payout ratio is 93.2%. Investors should continue to monitor the FCF payout ratio. If it goes above 100%, the dividend could be in danger of being cut.
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 Dow Chemical to My Watchlist.
- Add DuPont to My Watchlist.
- Add Monsanto to My Watchlist.
- Add PPG Industries to My Watchlist.
