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
SUPERVALU is a grocer going through a major turnaround in a challenging retail environment that even has Wal-Mart
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.
In 2010 SUPERVALU cut its dividend from $0.18 per quarter to $0.09 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, 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.
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
Another tool for better investing
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Follow Dan Dzombak on Twitter at @DanDzombak to check out his musings and see what articles he finds interesting. The Motley Fool owns shares of Whole Foods Market, SUPERVALU, and Wal-Mart Stores. Motley Fool newsletter services have recommended buying shares of Wal-Mart Stores and Whole Foods Market, creating a diagonal call position in Wal-Mart Stores, and buying calls in SUPERVALU. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.