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 Yamana Gold (NYSE: AUY), which yields 1.4%.

Yamana Gold is a gold miner that has been benefiting from the rising price of gold the past few years. However, gold miners' stock prices have been trailing the price of physical gold as represented by SPDR Gold Trust ETF (NYSE: GLD). Some miners are trying to rectify the difference by paying out dividends. Hecla Mining (NYSE: HL) has taken to pegging its dividend to its realized metal prices, while Gold Resource Corp. (AMEX: GORO) is considering paying a dividend in bullion instead of cash.

Yamana Gold Total Return Price Chart

Yamana Gold Total Return Price Chart by YCharts

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.

Yamana Gold Dividend Chart

Yamana Gold Dividend Chart by YCharts

Yamana Gold raised its dividend twice this year.

Immediate safety
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, which is 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. A ratio less than 1.5 is questionable; a number less than 1 means the company is not bringing in enough money to cover its interest expenses.

Yamana Gold Times Interest Earned TTM Chart

Yamana Gold Times Interest Earned TTM Chart by YCharts

Yamana Gold covers every $1 in interest expense with $45 in operating earnings.

The other tools we use to evaluate the safety of a dividend 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.

Yamana Gold's payout ratio, while volatile, has remained low.


Source: S&P Capital IQ.

There are some alternatives in the industry. Silvercorp Metals (NYSE: SVM) has the highest yield at 1.5% and a payout ratio of 20%. Silver Wheaton (NYSE: SLW) and Goldcorp (NYSE: GG) both have yields of 1.2% though Silver Wheaton has a much lower payout ratio than Goldcorp at 7.5%, compared to Goldcorp's 44%.

Another tool for better investing
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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.