As a dividend investor, it pays to follow how much of a company's money goes toward funding its dividend. A nice yield now won't matter much if the company can't keep making those payments going forward.

Here, we'll highlight a given company and its closest competitors to see just how safe their dividends are, with a little help from three crucial tools:

  • The interest coverage ratio, or 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 that the company is not bringing in enough money to cover its interest expenses.
  • 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' health. The FCF payout ratio measures the percent of free cash flow devoted toward paying the dividend. Again, a ratio greater 80% could be a red flag.

Let's examine Trinity Industries (NYSE: TRN) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

Trinity Industries

1.1%

1.8

28.4%

5.0%

Westinghouse Air Brake Technologies (NYSE: WAB)

0.2%

13.9

1.4%

1.9%

Ameron International (NYSE: AMN)

1.8%

15.8

27.2%

1471.8%

Valmont Industries (NYSE: VMI)

0.7%

6.2

16.8%

7.2%

Source: Capital IQ, a division of Standard & Poor's.

Trinity’s EPS payout ratio and FCF payout ratio are below 30% which is good. However, with an interest coverage of only 1.8, Trinity covers every $1 in interest expenses with only $1.8 in operating earnings. That’s manageable but is low enough that investors should monitor this number.

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 MyWatchlist, our free, personalized stock-tracking service.

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.