Dividend Coverage Ratio

Dividend coverage shows how sustainable a dividend is. A higher ratio means the company earns comfortably more than it pays out, leaving a cushion if profits fall.

For example, a company with earnings per share of 4.00 and dividends of 1.60 per share has dividend coverage of 2.5. It could pay its current dividend 2.5 times over from earnings.

A ratio below 1 means the company is paying out more than it earns, which may be funded from past profits, cash reserves or borrowing. This usually cannot continue for long, and may signal a dividend cut ahead.

Dividend coverage is the inverse of the dividend payout ratio: a coverage of 2.5 means a payout ratio of 40%. Because earnings include non-cash items, many analysts also check coverage using free cash flow. What counts as adequate coverage varies by industry; stable businesses such as utilities can often sustain lower coverage than cyclical companies.