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 than 80% could be a red flag.

Let's examine Golar LNG (Nasdaq: GLNG) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

Golar LNG 3.3% 2.3 306.0% 71.2%
Cheniere Energy Partners   (NYSE: CQP) 10.2% 1.3 603.3% 633.7%
Royal Dutch Shell (NYSE: RDS-B) 4.8% 27.6 44.1% 139.5%
ExxonMobil (NYSE: XOM) 2.4% 200.3 25.1% 44.7%

Source: Capital IQ, a division of Standard & Poor's.

With an interest coverage ratio of 2.3, Golar LNG covers every $1 in interest expenses with $2.3 in operating earnings. While its EPS payout ratio is almost 310%, its FCF payout ratio tells the real story at 71%. As such, you shouldn't have to worry that Golar LNG 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.

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