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.
Each of these ratios reflect dividends paid in the trailing 12 months; yields are the expected forward yield. Let's examine Windstream (NYSE: WIN) and three of its peers.
|
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
|---|---|---|---|---|
| Windstream |
7.6% |
2.1 |
187.7% |
98.9% |
| CenturyLink (NYSE: CTL) |
7.1% |
3.8 |
97.4% |
69.0% |
| Frontier Communications (NYSE: FTR) |
9.2% |
1.7 |
428.2% |
65.8% |
| Vodafone Group (NYSE: VOD) |
5.4% |
4.3 |
58.9% |
300.8% |
Source: Capital IQ, a division of Standard & Poor's.
With an interest coverage ratio of 2.1, Windstream covers every $1 in interest expenses with just more than $2 in operating earnings. Both its EPS and FCF payout ratios are high, with the EPS payout ratio at 187% and the FCF payout ratio nearing 100%. I believe Frontier Communications to be a better bet, even with its slightly lower interest coverage ratio.
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 Windstream to MyWatchlist.
- Add CenturyLink to MyWatchlist.
- Add Frontier Communications to MyWatchlist.
- Add Vodafone Group to MyWatchlist.
