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.

Let's examine Apache (NYSE: APA) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

Apache

0.7%

32.4

6.0%

10%

Chesapeake Energy (NYSE: CHK)

1.3%

72.3

20.8%

NM

Devon Energy (NYSE: DVN)

1.2%

10.9

4.8%

NM

EOG Resources (NYSE: EOG)

0.9%

3.3

39.6%

NM

Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful due to negative free cash flow.

With an interest coverage ratio of 32.4, Apache covers every $1 in interest expenses with more than $32 in operating earnings. Given that its EPS payout ratio and FCF payout ratio are below 10%, you shouldn't have to worry that Apache will need to cut its dividend anytime soon.

Another tool for better investing
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