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 Permian Basin Royalty Trust (NYSE: PBT), which yields 6.1%.

Permian Basin Royalty Trust is a royalty trust of oil fields in -- who would have guessed? -- the Permian Basin, which has seen some activity this year with Vanguard Natural Resoures' (NYSE: VNR) now fully owned subsidiary Encore Energy Partners buying a 46% stake in a limited partnership owned by Denbury Resources (NYSE: DNR). Royalty trusts don't pay taxes at the corporate level, so the tax burden gets passed to the investor. One thing to consider, however, is that unlike normal operating businesses, most trusts are depleting assets. A good example is Great Northern Iron Ore (NYSE: GNI), which is expecting to end operations in 2015. Eventually, the income-producing ability of the trust will end.

Permian Basin Royalty Trust Total Return Price Chart

Permian Basin Royalty Trust 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.

Permian Basin Royalty Trust Dividend Chart

Permian Basin Royalty Trust Dividend Chart by YCharts

Permian Basin Royalty Trust moves in line with the trust's production and realized prices on its sales of oil.

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.
  • 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 to paying the dividend.

Source: S&P Capital IQ.

As a trust, the company passes through its income to trust holders, and as such, the trust has a payout ratio of 100%.


Source: S&P Capital IQ.

There are some alternatives in the industry. San Juan Basin Royalty Trust (NYSE: SJT) has a slighgtly higher yield at 7.1%. BP Prudhoe Bay Royalty Trust (NYSE: BPT) also has a higher yield at 6.9%. SandRidge Mississippian Trust I (NYSE: SDT) has the highest trailing yield; however, that's due to a one-time large dividend it paid when it started operating. The trust's forward yield is closer to 8% at today's prices.

Another tool for better investing
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