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 Altria (NYS: MO) , which yields 5.6%.
Altria, like competitor Lorillard (NYS: LO) , is a manufacturer of cigarettes. Unlike Lorillard, Altria is the American manufacturer and seller of Marlboro, the No. 1 cigarette brand in the United States. In 2007 and 2008, the company went through a major restructuring. Altria spun off its food division, which became Kraft Foods (NYS: KFT) , and split up its American cigarette operations and its international operations, which became Philip Morris International (NYS: PM) . In 2009, Altria acquired UST, a maker of smokeless tobacco products that also competes with smokeless tobacco products from Star Scientific (NAS: CIGX) .
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.
Before the two spinoffs, Altria paid a dividend of $0.75 per quarter. After the spinoffs, the dividend was cut to $0.29 per quarter and has since risen to $0.41 per 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. It's 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. An interest coverage ratio less than 1.5 is questionable; a number less than one means the company is not bringing in enough money to cover its interest expenses.
Altria covers every $1 in interest expense with more than $5 in operating earnings.
The other tools we use to evaluate how safe a dividend is 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.
Altria targets a payout ratio of 80%, but lately it's been paying out slightly higher than 80%.
Source: S&P Capital IQ.
There are some alternatives out there in the industry. Reynolds American (NYS: RAI) has a similarly high dividend of 5.5% but a much higher payout ratio. Philip Morris International has the lowest payout ratio and a yield of 4.1%. British American Tobacco (NYS: BTI) rounds out the group with a 3.9% dividend and 57% payout ratio.
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At the time thisarticle was published FollowDan Dzombakon Twitter at@DanDzombakto check out his musings and see what articles he finds interesting. Heowns shares of Philip Morris International and Altria Group, but he holds no other position in any company mentioned.Click hereto see his holdings and a short bio. The Motley Fool owns shares of Altria Group and Philip Morris International.Motley Fool newsletter serviceshave recommended buying shares of Philip Morris International.Motley Fool newsletter serviceshave recommended creating a bear put ladder position in Lorillard. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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