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

The company we're looking at today is Energy Transfer Partners (NYSE: ETP), which yields 7.9%.

Energy Transfer Partners includes pipelines and other midstream operations. The company, like peer Kinder Morgan (NYSE: KMP), has been a steady performer as its operations are largely unaffected by the movements of oil and natural gas prices. The company also has a retail propane operation, similar to Suburban Propane Partners (NYSE: SPH).

Energy Transfer Partners Total Return Price Chart

Energy Transfer Partners 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.

Energy Transfer Partners Dividend Chart

Energy Transfer Partners Dividend Chart by YCharts

With its steady business, Energy Transfer Partners has a steady quarterly dividend of $0.89.

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, which is calculated by 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. A ratio less than 1.5 is questionable; a number less than one means the company is not bringing in enough money to cover its interest expenses.

Energy Transfer Partners Times Interest Earned TTM Chart

Energy Transfer Partners Times Interest Earned TTM Chart by YCharts

Energy Transfer Partners covers every $1 in interest expense with more than $7 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's 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.

Source: S&P Capital IQ.

Energy Transfer Partners' payout ratio has been steadily rising as its issued shares expand while its dividend stays the same.


Source: S&P Capital IQ.

There are some alternatives in the industry. Farrellgas Partners (NYSE: FGP) has a yield of 10.3% but a negative payout ratio. Linn Energy (Nasdaq: LINE) has a yield of 7.4% and a payout ratio of 118%. Enterprise Products Partners (NYSE: EPD) rounds out the group with a yield of 5.5%.

Another tool for better investing
Most investors don't keep tabs on their companies. That's a mistake. If you take the time to read past the headlines and crack a filing now and then, you're in a much better position to spot potential trouble early. We can help you keep tabs on your companies with My Watchlist, our free, personalized stock-tracking service.

For more dividend stock ideas, get The Motley Fool's free report, "11 Rock-Solid Dividend Stocks."

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.