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 3.13%, 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 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 (TTM) earnings per share are $7.92 and its TTM dividend per share is $1.73. Dividing the former by the latter shows that Rio Tinto has a TTM dividend cover of 4.57.
This is a positive sign for shareholders of Rio Tinto. 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
Income investing: what you need to know
For many investors, dividends are a vital part of their long-term strategy. That's why we have created a variety of income-focused stock screens, such as the Best Dividends Screen, to identify promising candidates for income portfolios. Take a look and see if any of the qualifying stocks might be worthy of further research.
As for Rio Tinto (LON:RIO), you can find a wealth of financial data on the group's StockReport, including information on the group's past and forecast dividend payments. If you’d like to discover more about dividend investing, you can read our free ebook: How to Make Money in Dividend Stocks.