The formula
How to calculate dividend coverage
Dividend cover asks how many times over a company could pay its dividend out of current earnings. It is the payout ratio inverted, and analysts prefer it because a multiple reads as a margin of safety.
The headroom figure translates the multiple into something more direct: how far profits could drop before the dividend and earnings meet. Cover of 1.67 means earnings could fall 40% before the payout consumes the lot.
What to enter:
- Earnings per share
- Dividend per share
The result updates on every keystroke. The URL updates too, which makes the filled-in version easy to bookmark or send to someone else.
Worked example
Take the figures the calculator starts with:
- Earnings per share: 3
- Dividend per share: 1.8
That gives:
- Dividend cover: 1.67 ×
- Earnings could fall by: 40 %
- Retained per share: 1.2
Reading the result
Cover around 2 is the conventional comfort zone. Between 1 and 1.5 the dividend depends on a good year continuing. Below 1 the company is paying out more than it earns, and the shortfall is coming from cash reserves or debt.
Where this goes wrong. Earnings are not cash. A company can report solid profits while free cash flow is negative, in which case a healthy-looking cover is being funded by the balance sheet. Run the same ratio against free cash flow per share before relying on it.
Around 2 times for a typical company, meaning half of earnings are paid out. Sectors with very stable cash flows, such as regulated utilities, are considered safe at lower cover because the earnings themselves vary less.
Because they are legally required to distribute most of their taxable income, and because depreciation depresses reported earnings without consuming cash. For REITs, cover is measured against funds from operations rather than earnings per share.
The answer it gives you is dividend cover. With 3 earnings per share and 1.8 dividend per share, that comes to 1.67 ×. Change any field and the figure moves with it.