Dividend investors know that it pays to follow how much of a company's money goes toward funding its payouts. 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 percentage of free cash flow devoted toward paying the dividend. Again, a ratio greater than 80% could be a red flag.
Each of these ratios reflect dividends paid in the trailing 12 months; yields are the expected forward yield. Let's examine Altria Group
Company |
Yield |
Interest Coverage |
EPS Payout Ratio |
FCF Payout Ratio |
---|---|---|---|---|
Altria Group | 6% | 5.7 | 92.7% | 68.3% |
Philip Morris International |
4.7% | 14.3 | 13.5% | NA |
Lorillard |
4.6% | 17.0 | 66.3% | 57.7% |
British American Tobacco |
4.1% | 9.0 | 73.2% | 71.4% |
Source: S&P Capital IQ.
With an interest coverage of 5.7, Altria covers every $1 in interest expenses with almost $6 in operating earnings. While its EPS payout ratio is a high 92.7%, Altria's FCF payout ratio is below 70%. As such, you shouldn't have to worry that Altria 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 Altria Group to My Watchlist.
- Add Philip Morris International to My Watchlist.
- Add Lorillard to My Watchlist.
- Add British American Tobacco to My Watchlist.