Investing term

What is Dividend coverage ratio?

How many times earnings (or free cash flow) cover the dividend — the inverse of the payout ratio.

Earnings ÷ dividends. Coverage of 2× (a 50% payout ratio) is robust; under about 1.2× is fragile, and below 1× means the company is paying out more than it earns and topping up the difference from cash, asset sales or debt. Using free cash flow rather than accounting earnings in the numerator is the stricter, more honest version of the test.

Dividend coverage ratio is taught hands-on in Stage 15 — Valuation for Investors.

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Related terms

Book valueTotal assets minus total liabilities — the accounting net worth of the business.DCF (discounted cash flow)Estimate intrinsic value by adding up the present value of every future cash flow the business produces.Discount rateThe annual rate used to translate future dollars back into today's dollars in a DCF.Dividend yieldAnnual dividend per share ÷ share price. The cash income the stock pays out as a percentage of price.
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