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.

Each of these ratios reflect dividends paid in the trailing twelve months while yields are the expected forward yield. Let's examine Safeway (NYSE: SWY)and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

Safeway

2.5%

4.2

34.7%

14.3%

SUPERVALU (NYSE: SVU)

3.7%

1.8

(4.9%)

10.7%

Walgreen (NYSE: WAG)

1.7%

50.6

27.5%

22.0%

CVS Caremark (NYSE: CVS)

1.4%

11.1

15.7%

13.7%

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

With an interest coverage of 4.2, Safeway covers every $1 in interest expenses with more than $4 in operating earnings. Given its EPS payout ratio is below 35% and its FCF payout ratio is below 15%, you shouldn't have to worry that Safeway 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.