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
EPS Payout Ratio
FCF Payout Ratio
Philip Morris International
British American Tobacco
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.
Follow Dan Dzombak on Twitter at @DanDzombak to check out his musings and see what articles he finds interesting. He owns shares of Altria and Philip Morris International. The Motley Fool owns shares of Altria Group and Philip Morris International. Motley Fool newsletter services have recommended buying shares of Philip Morris International and creating a bear put ladder position in Lorillard. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
More from The Motley Fool
3 High-Yield Stocks Still Worth Buying
Uncertainty is concerning for many investors, but some high-yield stocks warrant consideration despite the questions.
Here's What's Ahead for Altria Group in 2018
Find out if the cigarette giant can build on a quiet 2017.
How Safe Are Altria Group Inc (MO) and Its Dividend?
It all comes down to the length of your investing horizon.