Not all dividends are created equal. Here, we'll do a top-to-bottom analysis of a company to understand the quality of its dividend and see how it's changed over the past five years.

The company we're looking at today is Windstream (NYSE: WIN), which yields 8.8%.

Windstream is a rural telecom provider. The company and its competitors have been consolidating to benefit from economies of scale. Windtream acquired NuVox, Iowa Telecommunications Services, Hosted Solutions Acquisition, and Q-Comm just in 2010. Competitor CenturyLink (NYSE: CTL) made moves as well, buying Embarq and Qwest, while competitor Frontier Communications (NYSE: FTR) bought Verizon's (NYSE: VZ) rural wire-line business in 2010.

Windstream Corporation Total Return Price Chart

Windstream Corporation Total Return Price Chart by YCharts

To evaluate the quality of a dividend, the first thing to consider is whether the company has paid a dividend consistently over the past five years and, if so, how much it has grown.

Windstream Corporation Dividend Chart

Windstream Corporation Dividend Chart by YCharts

Windstream has maintained a $0.25 dividend per quarter for the past five years.

Immediate safety
To understand how safe a dividend is, we use three crucial tools, the first of which is:

  • The interest coverage ratio, or the number of times interest is earned, calculated by dividing earnings before interest and taxes 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.

Windstream Corporation Times Interest Earned TTM Chart

Windstream Corporation Times Interest Earned TTM Chart by YCharts

Windsream covers every $1 in interest expense with nearly $2 in operating earnings.

The other tools we use to evaluate the safety of a dividend are:

  • 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 to paying the dividend. Again, a ratio greater than 80% could be a red flag.

Source: S&P Capital IQ.

Windstream's payout ratio has been steadily rising. While the earnings payout ratio exceeds 100%, the free cash flow payout ratio remains near 80% which is high.


Source: S&P Capital IQ.

Although Windstream's dividend is high, so is its payout ratio. Alaska Communications Systems Group (Nasdaq: ALSK) has a massive trailing dividend of 18.9% but a trailing FCF payout ratio of nearly 140%. AT&T (NYSE: T), on the other hand, has a dividend yield of 6% and an FCF payout ratio of 65%. Verizon (NYSE: VZ) rounds out the group with a dividend of 5.2% and an FCF payout ratio of only 44%.

Another tool for better investing
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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.