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 Alliant Energy (NYS: LNT) , which yields 4.1%.
Alliant Energy is an electric utility. When the electricity market went through deregulation, utilities had to choose between being distributors or producers. Alliant'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.
Alliant's dividend has been steadily rising and now sits at $0.425 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, 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.
Alliant covers every $1 in interest expense with about $3 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.
Alliant's payout ratio jumped with the recession but has since come down to around 60%.
Source: S&P Capital IQ.
There are some alternatives in the industry. PG&E (NYS: PCG) has a yield of 4.4% and a payout ratio of 72%. OGE Energy (NYS: OGE) has a yield of 2.8% and a payout ratio of 43%. Last but not least is Constellation Energy Group (NYS: CEG) , with a yield of 2.4% and a payout ratio of 48%.
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