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
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
---|---|---|---|---|
Trinity Industries |
1.1% |
1.8 |
28.4% |
5.0% |
Westinghouse Air Brake Technologies |
0.2% |
13.9 |
1.4% |
1.9% |
Ameron International |
1.8% |
15.8 |
27.2% |
1471.8% |
Valmont Industries |
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.
- Add Trinity Industries to MyWatchlist.
- Add Westinghouse Air Brake Technologies to MyWatchlist.
- Add Ameron International to MyWatchlist.
- Add Valmont Industries to MyWatchlist.