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 Duke Energy
Duke Energy is an electric utility. When the electricity market went through deregulation, utilities had to choose between being distributors or producers. Duke chose distribution, and its electricity is sold in a largely regulated market. Since the company is largely regulated, it is stable like the average utility.
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.
Duke Energy's dividend has been rising steadily since 2007 and now rests at $0.25 per quarter.
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 1 means the company is not bringing in enough money to cover its interest expenses.
Duke Energy covers every $1 in interest expense with over $3 in operating earnings.
The other tool we use to evaluate the safety of a dividend is:
- 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.
Source: S&P Capital IQ.
While its payout jumped in 2008 with the downturn, the payout ratio has stayed below 80% more recently.
Source: S&P Capital IQ.
There are some alternatives in the industry, though none with as high a yield as Duke's. American Electric Power
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.
- Add Duke Energy to My Watchlist.
For more dividend stock ideas, get The Motley Fool's free report, "11 Rock-Solid Dividend Stocks."