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's 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 Pitney Bowes (NYSE: PBI) and three of its peers.
|
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
|---|---|---|---|---|
|
Pitney Bowes |
6.5% |
7.0 |
101.4% |
36.9% |
|
United Parcel Service (NYSE: UPS) |
3.0% |
17.2 |
50.4% |
50.0% |
|
Xerox (NYSE: XRX) |
1.8% |
5.7 |
26.6% |
20.8% |
|
R.R. Donnelley & Sons (NYSE: RRD) |
5.3% |
3.0 |
107.2% |
44.2% |
Source: Capital IQ, a division of Standard & Poor's.
With an interest coverage of 7.0, Pitney Bowes covers every $1 in interest expenses with $7 in operating earnings. While the company's EPS payout ratio of 101.4% would have you think the dividend is unsustainable, the company's FCF payout ratio is below 40%, so you shouldn't have to worry that Pitney Bowes 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 Pitney Bowes to My Watchlist.
- Add United Parcel Service to My Watchlist.
- Add Xerox to My Watchlist.
- Add R.R. Donnelley & Sons to My Watchlist.
