Not all dividends are created equal. Here, we'll do a top-to-bottom analysis of a company to understand the quality of its dividend and see how that's changed over the past five years.
The company we're looking at today is Southern Copper (NYS: SCCO) , which yields 7.8%.
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.
Southern Copper's dividend dipped with the financial crisis but has since come back strong.
To understand how safe a dividend is, we use two 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.
Southern Copper covers every $1 in interest expense with more than $18 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.
Southern Copper's payout ratio spiked with the financial crisis before the company cut its dividend. The payout ratio now sits at a high 80%.
Another tool for better investing
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