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 Weyerhaeuser (NYSE: WY), which yields 2.9%.

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 it has grown.

Weyerhaeuser Dividend Chart

Weyerhaeuser Dividend Chart by YCharts.

Weyerhaeuser's dividend had been stable at $0.60 per quarter until 2009, when the dividend dropped to $0.25 per quarter and then to $0.05 per quarter. In 2010, the company converted to a real estate investment trust, and in connection with this effort in September 2010, the company paid a special dividend of $26.46 in cash and shares. The company paid one more $0.05 dividend, and then the dividend was raised to $0.15 per quarter, where it has stayed since.

Immediate safety
To understand how safe a dividend is, we use a couple of 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.

Weyerhaeuser Times Interest Earned TTM Chart

Weyerhaeuser Times Interest Earned TTM Chart by YCharts.

At 1.36, Weyerhaeuser's interest coverage ratio is worrisome.

The other tool we use to evaluate the safety of a dividend is:

  • 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.

Source: S&P Capital IQ.

Weyerhaeuser had a rough 2009, reporting large losses. But the company's earnings have turned around since then, and the firm's payout ratio of 60% is manageable.

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.