Dividend coverage ratio explained
The Dividend Coverage Ratio, or dividend cover, is a way to see how many times a company can give dividends to its shareholders out of its profits.
How is coverage ratio used
The ratio tells you if a company can keep up with its dividend payments based on what it earns. Investors usually look for ratio larger than 2 but this is heavily depedent on business sector. Lower ratios are usually okay with Utilities companies but for example in Retail in might be warning sign.
To find the Dividend Coverage Ratio, you divide the company's net income by the dividends it plans to pay.
In this manner Dividend coverage ratio is reverse Payout Ratio which is more widely used and it’s showing the stock in same perspective.
DCR = (Net income - preferred dividends) / dividends.
Net income: is what the company earns after paying all its bills and taxes.
The dividends: are the cash it wants to give to shareholders.
Let's say a company earns 2400 bucks after taxes and wants to give out 1000 bucks in dividends. The dividend cover here would be 2.4. This means the company is earning enough to pay the dividend 2.4 times over.
When evaluating safety of dividend stocks the best first step you can take is to check out dividend safety score which evaluates 6 different paramaters including dividend payout ratio.