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 Teck Resources (NYSE: TCK) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio
Teck Resources 1.3% 7.0 20.8% 16.7%
Southern Copper (NYSE: SCCO) 7.3% 15.1 94.3% 93.3%
Freeport-McMoRan Copper & Gold (NYSE: FCX) 2% 24.0 12.2% 17.7%
Alcoa (NYSE: AA) 0.8% 3.3 16.7% 16%

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

With an interest coverage of 7.0, Teck Resources covers every $1 in interest expenses with $7 in operating earnings. Given that its EPS payout ratio and FCF payout ratio are around 20% or below, you shouldn't have to worry that Teck Resources will need to cut its dividend anytime soon. The company has been doing well and some analysts believe the company is a good bet for the long term.

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.