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 3M (NYSE: MMM) and three of its peers.

Company

Yield

Interest Coverage

EPS Payout Ratio

FCF Payout Ratio

3M 2.9% 32.0 37.1% 50.9%
General Electric (NYSE: GE) 3.7% 14.0 44.3% NA
Emerson Electric (NYSE: EMR) 2.9% 15.9 42.3% 49.6%
Ingersoll-Rand (NYSE: IR) 1.6% 5.4 42.2% NA

Source: S&P Capital IQ.

3M covers every $1 in interest expenses with $32 in operating earnings. Given that its EPS payout ratio and FCF payout ratio are below 50%, you shouldn't have to worry that 3M 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. Motley Fool newsletter services have recommended buying shares of 3M and Emerson Electric and creating a diagonal call position in 3M. 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.