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 Wisconsin Energy (NYSE: WEC), which yields 3.5%.

Wisconsin Energy is an electric utility. When the electricity market went through deregulation, utilities had to choose between being distributors or producers. Wisconsin Energy's electricity is sold in a largely regulated market. Since the company is largely regulated, the stock is stable like the average utility company.

Wisconsin Energy Corporation Total Return Price Chart

Wisconsin Energy 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.

Wisconsin Energy Corporation Dividend Chart

Wisconsin Energy Corporation Dividend Chart by YCharts

Wisconsin Energy's dividend has been steadily and rapidly increasing to $0.30 per quarter in 2012.

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 1 means the company is not bringing in enough money to cover its interest expenses.

Wisconsin Energy Corporation Times Interest Earned TTM Chart

Wisconsin Energy Corporation Times Interest Earned TTM Chart by YCharts

Wisconsin Energy covers every $1 in interest expense with nearly $4 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.

Wisconsin Energy has a low payout ratio of 43%.


Source: S&P Capital IQ.

There are some alternatives in the industry. Ameren (NYSE: AEE) has a yield of 4.9% and a payout ratio of 68%. Westar Energy (NYSE: WR) has a yield of 4.5% and also a payout ratio of 68%. Last but not least is NiSource (NYSE: NI), with a yield of 3.9% and a payout ratio of 82%.

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.

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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.