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 ESCO Technologies (NYS: ESE) , which yields 1.3%.
ESCO Technologies is an engineered products and systems company selling to the utility, industrial, and aerospace industries. While the company faces stiff competition from CLARCOR (NYS: CLC) and Pall (NYS: PLL) in the filtration sector, its Utility Solutions Group, which provides smart grid technologies, has been chugging along nicely. The segment contributed 50% of the company's revenue and 68% of its EBIT.
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.
ESCO has only paid a dividend since 2010; however, its quarterly dividend has been consistent.
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.
ESCO covers every dollar in interest expense with nearly $35 in operating earnings.
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.
Source: S&P Capital IQ.
ESCO Technologies' payout ratio has historically been low.
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