Not all dividends are created equal. Here, we'll do a top-to-bottom analysis of a company to understand the quality of its dividend and see how it's changed over the past five years.
The company we're looking at today is Windstream (NYS: WIN) , which yields 8.8%.
Windstream is a rural telecom provider. The company and its competitors have been consolidating to benefit from economies of scale. Windtream acquired NuVox, Iowa Telecommunications Services, Hosted Solutions Acquisition, and Q-Comm just in 2010. Competitor CenturyLink (NYS: CTL) made moves as well, buying Embarq and Qwest, while competitor Frontier Communications (NYS: FTR) bought Verizon's (NYS: VZ) rural wire-line business in 2010.
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.
Windstream has maintained a $0.25 dividend per quarter for the past five years.
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, calculated by dividing earnings before interest and taxes 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 1 means that the company is not bringing in enough money to cover its interest expenses.
Windsream covers every $1 in interest expense with nearly $2 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' health. The FCF payout ratio measures the percentage of free cash flow devoted to paying the dividend. Again, a ratio greater than 80% could be a red flag.
Source: S&P Capital IQ.
Windstream's payout ratio has been steadily rising. While the earnings payout ratio exceeds 100%, the free cash flow payout ratio remains near 80% which is high.
Source: S&P Capital IQ.
Although Windstream's dividend is high, so is its payout ratio. Alaska Communications Systems Group (NAS: ALSK) has a massive trailing dividend of 18.9% but a trailing FCF payout ratio of nearly 140%. AT&T (NYS: T) , on the other hand, has a dividend yield of 6% and an FCF payout ratio of 65%. Verizon (NYS: VZ) rounds out the group with a dividend of 5.2% and an FCF payout ratio of only 44%.
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