The past week we added new data to our fundamental data-set and stock screeners.
Dividend Coverage Ratio (DCR)
The Dividend Coverage Ratios allow you to evaluate the safety of a company’s dividend. The dividend coverage ratio is calculated by dividing a company’s annual Earnings per Share (EPS) by its annual Dividend per Share (DPS) or dividing its net income less required dividend payments.
Generally, a higher dividend coverage ratio is more favorable. A DCR above 2 is considered as a healthy ratio. When evaluating a dividend stock and dividend safety, please take into account other popular ratios such as the dividend payout ratio, free cash flow to equity, and Net Debt to EBITDA.
Some additional info can be found in this article.
Dividend stocks “safety” can also be measured based on above-average market capitalizations and liquidity, balance-sheet strength (per their Altman Z-score).
The Altman Z Score Formula in short:
- Altman Z score of greater than 2.99 means that the entity being measured is safe from bankruptcy (“Safe-Zone”).
- A score below 1.81 means that a business is at considerable risk of going into bankruptcy (“Bankruptcy-Zone or Distress-Zone”),
- while scores in between should be considered a red flag for possible problems. (“Grey-Zone”).
The study by Altman found that companies that are in Distress Zone have more than 80% of the chance of bankruptcy in two years. Please be aware that the Altman Z-Score does not apply to financial companies.
The Altman-Z score is now available for Dividend Aristocrats (US) and Dividend Kings.
A practical example 3M (MMM)
The original Z-score formula is as follows:
- Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5.
- X1 = working capital / total assets. Measures liquid assets in relation to the size of the company.
- X2 = retained earnings / total assets. Measures profitability that reflects the company’s age and earning power.
- X3 = earnings before interest and taxes / total assets. Measures operating efficiency apart from tax and leveraging factors. It recognizes operating earnings as being important to long-term viability.
- X4 = market value of equity/book value of total liabilities. Adds market dimension that can show up security price fluctuation as a possible red flag.
- X5 = sales / total assets. The standard measure for total asset turnover (varies greatly from industry to industry).
The 3M (MMM) Altman Z-Score of 4.05, indicating it is in the Safe Zone, is calculated as follows with the above formula (April 2020):