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 Pepco
Pepco is an electic utility. When the electricity market went through deregulation, utilities had to choose between being distributors or producers. Pepco's electricity is sold in a largely regulated market. Since the company is largely regulated, the stock is stable like the average utility company.
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.
Pepco last raised its dividend in 2008 from $0.26 per quarter to $0.27 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.
Pepco covers every $1 in interest expense with just over $2.50 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.
Pepco's payout ratio went sky-high during the recession, but has since come down to its current level of 90%.
Source: S&P Capital IQ.
There are some alternatives in the industry, though none with as high a yield as Pepco's. Coming closest is TECO Energy
Another tool for better investing
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- Add Pepco to My Watchlist.
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