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 Consolidated Edison (NYS: ED) , which yields 3.9%.
Consolidated Edison is an electric utility. When the electricity market went through deregulation, utilities had to choose between being distributors or producers. ConEd'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.
Consolidated Edison's dividend has risen steadily over the past five years to $0.60 per quarter in 2011.
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.
Consolidated Edison covers every $1 in interest expense with nearly $4 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.
Consolidated Edison's payout ratio spiked to just under 100% in the middle of the recession, but it has been coming down since and now rests at 64%.
Source: S&P Capital IQ.
There are some alternatives in the industry. Otter Tail (NAS: OTTR) has a yield of 5.4% but a payout ratio of 134%. Exelon (NYS: EXC) has a yield of 4.8% and a payout ratio of 58%. Last but not least, CenterPoint (NYS: CNP) has a yield of 3.9% and a payout ratio of just 24.5%.
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