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.
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.
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 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.
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 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.
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