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 SUPERVALU (NYSE: SVU), which yields 4.5%.

SUPERVALU is a grocer going through a major turnaround in a challenging retail environment that even has Wal-Mart (NYSE: WMT) and Safeway (NYSE: SWY) reporting low same-store sales. SUPERVALU has been paying down its large debt load since 2008 and is continuing to make significant progress. The market appears to not believe the company is going to make it and has crushed the stock the past five years.

SUPERVALU Total Return Price Chart

SUPERVALU 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.

SUPERVALU Dividend Chart

SUPERVALU Dividend Chart by YCharts

In 2010 SUPERVALU cut its dividend from $0.18 per quarter to $0.09 per quarter.

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.

SUPERVALU Times Interest Earned TTM Chart

SUPERVALU Times Interest Earned TTM Chart by YCharts

At 1.19, SUPERVALU's interest coverage ratio is worrisome.

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 percentage of free cash flow devoted to paying the dividend. Again, a ratio greater than 80% could be a red flag.

Source: S&P Capital IQ.

SUPERVALU's payout ratio spiked in 2008 before the company cut its dividend. It is now sitting right below 20%.


Source: S&P Capital IQ.

There are some alternatives in the industry though none with as high of a yield. Walgreen (NYSE: WAG) has a yield of 2.8% and a payout ratio of 27%. Kroger (NYSE: KR) has a yield of 2% and a payout ratio of 31.6%. Whole Foods Market (NYSE: WFM) rounds out the lot with a yield of 0.9% and a payout ratio of 23.5%.

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.

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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.