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 Selective Insurance Group
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.
Selective Insurance Group raised its dividend in late 2007 from $0.12 to $0.13 per quarter, where it has remained since.
To understand how safe a dividend is, we use two crucial tools, first:
- 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.
Selective Insurance Group covers every $1 in interest expense with just $2 in operating earnings. Investors should carefuly watch this number.
We use another tool to evaluate the safety of a 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'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.
Selective Insurance Group's free cash flow payout ratio has been slowly rising the past 5 years but still remains low at 20%.
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 open 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.
- Add Selective Insurance Group to My Watchlist.
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