Brown-Forman's Dividend X-ray

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 Brown-Forman (NYS: BF.B) (NYS: BF.A) , which yields 1.9%.

Brown-Forman is one of the giants of the alcoholic beverages industry, along with Diageo (NYS: DEO) , Constellation Brands (NYS: STZ) , and Beam (NAS: BEAM) . Its Jack Daniel's brand is a key differentiator in keeping competitors at bay.

Brown-Forman Corporation Total Return Price Chart

Brown-Forman Corporation Total Return Price Chart by YCharts.

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.

Brown-Forman Corporation Dividend Chart

Brown-Forman Corporation Dividend Chart by YCharts.

Brown-Forman has slowly but steadily increased its quarterly dividend from $0.25 a quarter in 2007 to $0.35 per quarter in the most recent quarter.

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.

Brown-Forman Corporation Times Interest Earned (TTM) Chart

Brown-Forman Corporation Times Interest Earned (TTM) Chart by YCharts.

Brown-Forman covers every dollar in interest expense with nearly $29 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.

Brown-Forman's payout ratio has historically been low.

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 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.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story