There is some evidence that buying progressive dividend payers with solid balance sheets is a strategy well-rewarded by the market. After all, who doesn’t like a steady stream of predictable cash payments?
A reputation as a dependable dividend payer takes years to forge and, once created, is a valuable way for a company to signal its long-term profitability to the market and prospective shareholders. This is why, when it comes to dividend-paying companies such as large cap Integrated Mining operator Rio Tinto (LON:RIO), which yields 4.93%, it is useful to check how well these payments are covered by earnings.
Earnings per share divided by dividend per share is called dividend cover - and it’s a great way to quickly gauge a company’s capacity to continue its dividend payments
How to interpret Rio Tinto’s (LON:RIO) dividend cover
Generally speaking, a dividend cover of below 1.5 times is cause for concern. Above 1.5 is good, but it is when you are getting above two times cover that you see the sign of a high-quality, sustainable dividend payment. Let’s see how Rio Tinto measures up.
The group’s trailing twelve month earnings per share are $7.88 and its trailing twelve month dividend per share is $2.97. Dividing the former by the latter shows that Rio Tinto has a trailing twelve month dividend cover of 2.65. One point worth noting is that, while reported EPS came in at $7.88, normalised EPS was much lower at $4.41. It is worth consulting the group's Annual Report to understand the difference between these two earnings figures.
Other checks you can perform to assess dividend safety include:
- Checking the current ratio is above 1.5 times and preferably above 2x
- Making sure dividend per share is covered by free cash flow per share
- Assessing balance sheet health by looking at the group’s gearing ratio
Disclaimer: These articles are provided for information purposes only. The content is not intended to be a personal recommendation. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser. The author has no position in the stocks mentioned, unless otherwise stated.