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 Freeport-McMoRan Copper & Gold (NYSE: FCX), which yields 2.3%.

Freeport-McMoRan Copper & Gold is a miner of copper and gold based in Phoenix. The stock was crushed in 2008 with the financial crisis because of its large debt load, but has since come back.

Freeport-McMoran Copper & Gold Total Return Price Chart

Freeport-McMoran Copper & Gold 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 has it grown.

Freeport-McMoran Copper & Gold Dividend Chart

Freeport-McMoran Copper & Gold Dividend Chart by YCharts

Contrary to how it appears on the graph, Freeport-McMoRan Copper & Gold cut its dividend in 2009 and then reinstated it in 2010 at $0.15 per quarter. The company has since raised its dividend to $0.25 per quarter.

Immediate safety
To understand how safe a dividend is, we first look at:

  • The interest coverage ratio or the number of times interest is earned, 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. An interest coverage 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.

Freeport-McMoran Copper & Gold Times Interest Earned TTM Chart

Freeport-McMoran Copper & Gold Times Interest Earned TTM Chart by YCharts

Freeport-McMoRan covers every $1 in interest expense with $29 in operating earnings.

Another tool we use to evaluate how safe 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.

Freeport-McMoRan was unprofitable in 2008 and early 2009; at all other times, the company's payout ratio has been a low 20%.

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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