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 Teva Pharmaceuticals (NAS: TEVA) , which yields 1.5%.
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.
Teva Pharmaceuticals has slowly been raising its dividend the past five years. Most recently, the company paid out $0.22.
The main 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' health. The FCF payout ratio measures the percentage of free cash flow devoted to paying the dividend. Again, a ratio greater than 80% could be a red flag.
Source: S&P Capital IQ.
While Teva's free cash flow payout ratio fluctuated some in 2008 and 2009, since that time both payout ratios have come to rest near 30%, a very low level.
Another tool for better investing
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