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 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 percent of free cash flow devoted toward paying the dividend. Again, a ratio greater than 80% could be a red flag.
Each of these ratios reflect dividends paid in the trailing 12 months, while yields are the expected forward yield. Let's examine Lancaster Colony
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
---|---|---|---|---|
Lancaster Colony |
2.2% |
N/A |
35.3% |
41.9% |
Campbell Soup |
3.4% |
10.8 |
46.5% |
55.2% |
HJ Heinz |
3.6% |
6.0 |
58.8% |
75.3% |
ConAgra Foods |
3.7% |
7.9 |
47.5% |
51.5% |
Source: Capital IQ, a division of Standard & Poor's.
Lancaster Colony does not have any debt, and as such it has no interest to cover. Given its EPS payout ratio and FCF payout ratio are below 45%, you shouldn't have to worry that Lancaster Colony 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 Lancaster Colony to My Watchlist.
- Add Campbell Soup to My Watchlist.
- Add HJ Heinz to My Watchlist.
- Add ConAgra Foods to My Watchlist.