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 NutriSystem (Nasdaq: NTRI) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio
NutriSystem

4.9%

126.9

80.5%

80%
Weight Watchers International (NYSE: WTW)

0.9%

5.7

23.5%

15.1%
Avon Products (NYSE: AVP)

3.3%

13.8

54.9%

120.6%
Herbalife (NYSE: HLF)

1.4%

42.3

18.1%

21.8%

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

With an interest coverage of 126.9, NutriSystem covers every $1 in interest expenses with just under $130 in operating earnings. Given that its EPS payout ratio and FCF payout ratio are at 80%, you should be concerned that NutriSystem might need to cut its dividend in the future. While the company generated $25 million in free cash flow in the past four quarters, it also took out $30 million in debt to help buy back $75 million in shares and pay its $20 million dividend.

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