As a dividend investor, it pays to follow how much of a company's money goes toward funding its dividend. A nice yield now won't matter much if the company can't keep making those payments going forward.
Here, we'll highlight a given company and its closest competitors to see just how safe their dividends are, with a little help from three crucial tools:
The interest coverage ratio, or 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. An interest coverage ratio less than 1.5 is questionable; a number less than one means that the company is not bringing in enough money to cover its interest expenses.
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' health. The FCF payout ratio measures the percent of free cash flow devoted toward paying the dividend. Again, a ratio greater 80% could be a red flag.
Let's examine Cliffs Natural Resources (NYS: CLF) and three of its peers.
EPS Payout Ratio
FCF Payout Ratio
Cliffs Natural Resources
Peabody Energy (NYS: BTU)
CONSOL Energy (NYS: CNX)
Arch Coal (NYS: ACI)
Source: Capital IQ, a division of Standard & Poor's.
With an interest coverage of 12.3, Cliffs covers every $1 in interest expenses with $12 in operating earnings. Given its EPS payout ratio and FCF payout ratio below 10%, you shouldn't have to worry that Cliffs will need to cut its dividend anytime soon.
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.
Add Cliffs Natural Resourcesto My Watchlist.
Add Peabody Energyto My Watchlist.
Add CONSOL Energyto My Watchlist.
Add Arch Coalto My Watchlist.
At the time thisarticle was published Follow Dan Dzombak on Twitter at @DanDzombak to check out his musings and see what articles he finds interesting. 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.
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