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Dividend Coverage Ratio & Free Cash Flow Analysis

Overview

Go beyond the basic payout ratio with dividend coverage analysis. Free cash flow coverage, debt service coverage, and multi-year trend analysis reveal the true sustainability of a dividend. Ground your numbers using our cash-flow statement deep dive and review earnings trends in the income statement guide. Quickly surface at-risk payers by running coverage filters in the stock screener.

Key Takeaways

  • Dividend coverage ratio = earnings per share / dividends per share (inverse of payout ratio).
  • A coverage ratio above 2.0 means the company earns twice what it pays — very safe.
  • Free cash flow coverage = operating cash flow − capex / total dividends paid.
  • Companies can maintain dividends from debt temporarily — but it's not sustainable.

Practical Tips

  • Calculate FCF coverage for the last 5 years — one bad year is fine, three is a pattern.
  • Check if capex is discretionary (can be reduced) or maintenance (must be spent).
  • Cross-reference with debt-to-EBITDA: highly leveraged dividend payers are the riskiest.

More Analysis Guides

Payout Ratio — Is the Dividend Safe?

The payout ratio tells you what percentage of earnings a company pays as dividends. It's the single most important metric for assessing whether a dividend is sustainable or at risk of being cut. Learn to read the numbers behind the ratio in our <a href="/academy/fundamental-analysis/reading-an-income-statement" class="text-primary hover:underline">income statement guide</a>, then cross-reference with <a href="/academy/fundamental-analysis/cash-flow-statement-deep-dive" class="text-primary hover:underline">cash-flow analysis</a>. For a more advanced multi-year approach, continue to <a href="/academy/dividends/dividend-coverage-ratio" class="text-primary hover:underline">Dividend Coverage Ratio & Free Cash Flow Analysis</a>.

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