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's 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.

Each of these ratios reflects dividends paid in the trailing 12 months, while yields are the expected forward yield. Let's examine Lowe's (NYSE: LOW) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

Lowe's Companies

2.6%

10.3

32.2%

22.1%

The Home Depot (NYSE: HD)

2.8%

11.8

44.4%

36.2%

Wal-Mart Stores (NYSE: WMT)

2.6%

11.2

28.4%

75.4%

Tractor Supply (Nasdaq: TSCO)

0.7%

184.7

14%

395.4%

Source: S&P Capital IQ.

With an interest coverage of 10.3, Lowe's covers every $1 in interest expenses with $10 in operating earnings. Given that its EPS payout ratio and FCF payout ratio are below 35%, you shouldn't have to worry that Lowe's will need to cut its dividend anytime soon.

Another tool for better investing
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Follow Dan Dzombak on Twitter at @DanDzombak to check out his musings and see what articles he finds interesting. The Motley Fool owns shares of Wal-Mart Stores. Motley Fool newsletter services have recommended buying shares of Lowe's Companies, Wal-Mart Stores, and The Home Depot. Motley Fool newsletter services have recommended writing covered calls in Lowe's Companies, as well as creating a diagonal call position in Wal-Mart Stores. 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.