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
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