CenturyLink's Dividend X-ray

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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 see how that's changed over the past five years.

The company we're looking at today is CenturyLink (NYS: CTL) , which yields 8.2%.

Industry
CenturyLink is a rural telecommunications company that has been pursuing a strategy of growth through mergers. The past few years, CenturyLink has spent roughly $38 billion buying Embarq -- a spinoff of Sprint Nextel (NYS: S) -- as well as Qwest and Savvis. Similarly, competitor Frontier Communications (NYS: FTR) greatly expanded its own size by making a huge move in 2010 to buy Verizon's (NYS: VZ) rural-wireline business.

CenturyLink Total Return Price Chart by YCharts

Dividend
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.

CenturyLink Dividend Chart

CenturyLink Dividend Chart by YCharts

CenturyLink's dividend took a big jump in 2008 with the acquisition of Embarq.

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.

CenturyLink Times Interest Earned (TTM) Chart

CenturyLink Times Interest Earned (TTM) Chart by YCharts

CentruyLink covers every dollar of interest expense with just over $2 in operating earnings.

Sustainability
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 percent of free cash flow devoted toward paying the dividend. Again, a ratio greater than 80% could be a red flag.
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Source: S&P Capital IQ.

CenturyLink's payout ratio has remained steady near 50%, while its earnings payout ratio has been more volatile.

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.

At the time this article was published FollowDan Dzombakon Twitter at@DanDzombakto check out his musings and see what articles he finds interesting. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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