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 Freeport-McMoRan Copper & Gold (NYS: FCX) , which yields 2.3%.
Freeport-McMoRan Copper & Gold is a miner of copper and gold based in Phoenix. The stock was crushed in 2008 with the financial crisis because of its large debt load, but has since come back.
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.
Contrary to how it appears on the graph, Freeport-McMoRan Copper & Gold cut its dividend in 2009 and then reinstated it in 2010 at $0.15 per quarter. The company has since raised its dividend to $0.25 per quarter.
To understand how safe a dividend is, we first look at:
The interest coverage ratioorthe 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 the company is not bringing in enough money to cover its interest expenses.
Freeport-McMoRan covers every $1 in interest expense with $29 in operating earnings.
Another tool we use to evaluate how safe 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.
Freeport-McMoRan was unprofitable in 2008 and early 2009; at all other times, the company's payout ratio has been a low 20%.
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