Not all dividends are created equal. Here, we'll do a top to bottom analysis of a given company to understand the quality of its dividend and how that's changed over the past five years.
The company we're looking at today is Altria
Altria, like competitor Lorillard
To evaluate the quality of a dividend, the first thing to consider is whether the company has paid a dividend consistently over the past five years and, if so, how much has it grown.
Before the two spinoffs, Altria paid a dividend of $0.75 per quarter. After the spinoffs, the dividend was cut to $0.29 per quarter and has since risen to $0.41 per quarter.
To understand how safe a dividend is we use three crucial tools, the first of which is the interest coverage ratio or the number of times interest is earned. It's calculated by 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 one means the company is not bringing in enough money to cover its interest expenses.
Altria covers every $1 in interest expense with more than $5 in operating earnings.
The other tools we use to evaluate how safe a dividend is are:
- 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.
Source: S&P Capital IQ.
Altria targets a payout ratio of 80%, but lately it's been paying out slightly higher than 80%.
Source: S&P Capital IQ.
There are some alternatives out there in the industry. Reynolds American
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 to My Watchlist.
For more dividend stock ideas, get The Motley Fool's free report, "11 Rock-Solid Dividend Stocks."
Follow Dan Dzombak on Twitter at @DanDzombak to check out his musings and see what articles he finds interesting. He owns shares of Philip Morris International and Altria Group, but he holds no other position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Altria Group and Philip Morris International. Motley Fool newsletter services have recommended buying shares of Philip Morris International. Motley Fool newsletter services have recommended creating a bear put ladder position in Lorillard. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.