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 Marathon Oil (NYSE: MRO) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio
Marathon Oil

1.9%*

44.0

22.9%

19.1%
ConocoPhillips (NYSE: COP)

3.5%

13.0

27.8%

37.4%
Valero Energy (NYSE: VLO)

0.8%

4.5

21.5%

6.1%
Chevron (NYSE: CVX)

3.0%

952.7

28.0%

54.3%

Source: Capital IQ, a division of Standard & Poor's. *Based on expected $0.15 quarterly dividend following spinoff of refining division.

With an interest coverage ratio of 44.0, Marathon Oil covers every $1 in interest expenses with $44 in operating earnings. Given its EPS payout ratio and FCF payout ratio are below 25%, you shouldn't have to worry that Marathon Oil will need to cut its dividend anytime soon. The company has been doing well, and it recently spun off its refining division as Marathon Petroleum (NYSE: MPC) to make it a more easily valued business and to rid itself of its conglomerate discount. Investors should be aware that the two Marathon entities plan to divide their previous dividend, so Marathon Oil shareholders will get a smaller per-share dividend to reflect the portion that goes to Marathon Petroleum shareholders.

Another tool for better investing
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