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 than 80% could be a red flag.
Let's examine Lawson Products(Nasdaq: LAWS) and three of its peers.
|
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
|---|---|---|---|---|
|
Lawson Products |
2.6% |
20.3 |
49.1% |
15.3% |
|
Fastenal (Nasdaq: FAST) |
1.6% |
NA |
46.9% |
98.2% |
|
W.W. Grainger (NYSE: GWW) |
1.8% |
117.4 |
27.7% |
37.5% |
|
Barnes Group (NYSE: B) |
1.3% |
5.2 |
29.6% |
1356.9% |
Source: Capital IQ, a division of Standard & Poor's.
With an interest coverage of 20.3, Lawson Products covers every $1 in interest expenses with more than $20 in operating earnings. While its EPS payout ratio is nearly 50%, the company's FCF payout tells the real story and is below 20%. As such, you shouldn't have to worry that Lawson Products will need to cut its dividend anytime soon.
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.
- Add Lawson Products to My Watchlist.
- Add Fastenal to My Watchlist.
- Add W.W. Grainger to My Watchlist.
- Add Barnes Group to My Watchlist.
