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 than 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 Scotts Miracle-Gro (NYSE: SMG) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

Scotts Miracle-Gro 2.4% 7.2 35.6% 40.9%
Terra Nitrogen (NYSE: TNH) 8.7% 1170.0 60.5% 82%
PotashCorp (NYSE: POT) 0.5% 38.0 7.3% 39.9%
Mosaic (NYSE: MOS) 0.3% 196.2 3.3% 8.4%

Source: S&P Capital IQ.

With an interest coverage of 7.2, Scotts Miracle-Gro covers every $1 in interest expenses with more than $7 in operating earnings. Given that its EPS payout ratio and FCF payout ratio around or below 40%, you shouldn't have to worry that Scotts Miracle-Gro will need to cut its dividend anytime soon.

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Follow Dan Dzombak on Twitter at @DanDzombak to check out his musings and see what articles he finds interesting. Motley Fool newsletter services have recommended buying shares of Scotts Miracle-Gro. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.