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 Calumet Specialty Products Partners (Nasdaq: CLMT) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio
Calumet Specialty Products Partners

8.1%

2.1

201.1%

37.2%
ConocoPhillips (NYSE: COP)

3.5%

13.0

27.8%

46.0%
Valero Energy (NYSE: VLO)

0.7%

5.3

8.2%

8.7%
Exxon Mobil (NYSE: XOM)

2.2%

200.3

25.1%

44.7%

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

With an interest coverage of 2.1, Calumet Specialty Products Partners covers every $1 in interest expenses with just over $2 in operating earnings. While its EPS payout ratio is a whopping 200%, its FCF payout ratio tells the real story and is below 40%, and as such you shouldn't have to worry that Calumet Specialty Products Partners  will need to cut its dividend anytime soon.

Another tool for better investing
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