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 twelve months while yields are the expected forward yield. Let's examine CF Industries (NYSE: CF) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

CF Industries

0.2%

5.5

4.5%

1.8%

Sociedad Quimica y Minera (NYSE: SQM)

1.1%

14.9

45.8%

81.7%

Terra Nitrogen (NYSE: TNH)

12.4%

962.7

64.5%

40.3%

PotashCorp (NYSE: POT)

0.5%

23.5

7.5%

38.4%

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

With an interest coverage ratio of 5.5, CF Industries covers every $1 in interest expenses with more than $5 in operating earnings. Given its EPS payout ratio and FCF payout ratio are below 5%, you shouldn't have to worry that CF Industries will need to cut its dividend anytime soon.

Another tool for better investing
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