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 Hawaiian Electric (NYS: HE) , which yields 4.7%.
Hawaiian Electric is an electric utility. When the electricity market went through deregulation, utilities had to choose between being distributors or producers. Hawaiian's electricity is sold in a largely regulated market. Since the company is largely regulated, the stock is stable like the average utility company.
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.
Hawaiian Electric's dividend has been stable at $0.31 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, 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.
Hawaiian Electric covers every $1 in interest expense with $3 in operating earnings.
The other tool we use to evaluate the safety of a dividend is:
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.
Source: S&P Capital IQ.
Hawaiian Electric's payout ratio went way up during the recession but since then has been steadily falling the past two years to its current 91%.
Source: S&P Capital IQ.
There are some alternatives in the industry. PPL (NYS: PPL) also has a yield of 4.7%, but has a much lower payout ratio than Hawaiian Electric at 53%. Progress Energy (NYS: PGN) has a yield of 4.5% and a payout ratio of 95%. Last but not least is Dominion Resources (NYS: D) , with a yield of 3.7% and a payout ratio of 74%.
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At the time thisarticle was published Follow Dan Dzombak on Twitter at @DanDzombak to check out his musings and see what articles he finds interesting. Motley Fool newsletter services have recommended buying shares of Dominion Resources. 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.