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 Teekay Tankers (NYS: TNK) , which yields 16.7%.
Teekay Tankers is a shipping company that focuses on oil tankers. The tanker market had been stabler than other shipping markets, which have greatly hurt companies such as DryShips (NAS: DRYS) , but weakness this year has been hurting all tanker companies. Competitors Overseas Shipping Group and Ship Finance International (NYS: SFL) have been hurting, while some think Frontline (NYS: FRO) is on the brink of death.
To evaluate the quality of a dividend, the first thing to consider is, has the company paid a dividend consistently over the past five years and if so, how much has it grown.
Teekay's dividend has tracked the strength and weakness of the industry, and has been declining since 2010.
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 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 1 means that the company is not bringing in enough money to cover its interest expenses.
Teekay covers every $1 in interest expense with $16 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.
Teekay Tankers distributes the majority of its cash flow to shareholders, and, as such, its payout ratio is consistently high.
Source: S&P Capital IQ
There are some alternatives out there in the industry. Nordic American Tankers (NYS: NAT) has a similar policy of paying out the majority of its cash flow, sporting a yield of 9.9%. DHT (NYS: DHT) has the same yield as Teekay Tankers, while Golar LNG (NAS: GLNG) rounds out the list with a yield of 2.8%. All three have negative free cash flow, which is why they show up at the bottom of the graph above.
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.
Add Teekay Tankers to My Watchlist.
For more dividend stock ideas, get The Motley Fool's free report, "11 Rock-Solid Dividend Stocks."
At the time thisarticle was published FollowDan Dzombakon Twitter at@DanDzombakto check out his musings and see what articles he finds interesting.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.
Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.