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 Graco
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
---|---|---|---|---|
Graco | 1.8% | 47.7 | 41.8% | 77.3% |
Flowserve |
1.1% | 16.9 | 16.6% | 115.9% |
IDEX |
1.5% | 14.6 | 30.7% | 36% |
Gorman-Rupp |
0.9% | NA | 24.6% | 102.3% |
Source: Capital IQ, a division of Standard & Poor's.
With an interest coverage ratio of 47.7, Graco covers every $1 in interest expenses with more than $47 in operating earnings. Its 42% EPS payout ratio is good, but investors should watch out for Graco's FCF payout ratio, which currently stands at a much higher 77.3%.
Another tool for better investing
Most investors don't keep tabs on their companies and 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 Graco to MyWatchlist.
- Add Flowserve to MyWatchlist.
- Add IDEX to MyWatchlist.
- Add Gorman-Rupp to MyWatchlist.