Delving into dividends: What is dividend cover?

Julie Brownlee, Fsp Invest, 17 Dec. 2014

Tags: dividend cover, dividends, dividend, checking company dividend, eps, free cash flow,

When you invest on the stock market, one aspect you might be interested in is looking at companies that pay dividends.

Dividends are a way a company can distribute profits back to its shareholders.

So if you want to invest in a company that pays dividends, how can you check if it’s going to keep paying them?

You can check its dividend cover.

Read on to find out how you can calculate this…

How to calculate a company’s dividend cover

If you hold shares in a company that pays a dividend, it’s satisfying to receive your pay out twice a year.

So how can you check whether a company’s going to increase its dividend payment? Or cut it all together?

You can get an indication from calculating its dividend cover.

To calculate a company’s dividend cover, divide the company’s earnings per share (EPS) by its dividend per share. This shows you how many times the company’s profits cover the dividend.

Let’s take a look at an example…

Say Company ABC has EPS of 30c. It pays a dividend of 10c. So its dividend cover is 3. In other words, its dividend is covered three times.

With a dividend cover of 3, chances are the company would have to see a large drop in profits before it would consider cutting its dividend.

You can also use free cash flow to calculate a company’s dividend cover

To double check dividend cover, it’s a good idea to do the same calculation with the company’s free cash flow instead of EPS. This is because earnings don’t equal cash, which a company needs to pay dividends.

To get a company’s free cash flow, just look at its cash flow statement. If it doesn’t list its free cash flow on a per share basis, just divided the figure by the amount of shares in issue.

So there you have it, what dividend cover is.

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