Coverage = Net Income / Dividends Paid = EPS / DPS; conservative = Free Cash Flow / Dividends Paid
Dividend coverage shows how comfortably earnings fund the dividend.
What it is
The Dividend Coverage Ratio measures how comfortably a company can pay its dividend out of profits. It is the inverse of the payout ratio: a coverage ratio of 2 means earnings are twice the dividend, equal to a 50% payout ratio. It can be built from net earnings or, more conservatively, from free cash flow.
Why it matters
Higher coverage means a bigger cushion, so a temporary dip in earnings is less likely to force a dividend cut. Coverage near or below 1 is a warning that the dividend is being paid out of nearly all profit (or from debt or reserves) and may not be sustainable.
How it's calculated
Divide net income by total dividends paid (or use per-share figures: EPS divided by dividend per share). For a stricter view, divide free cash flow by dividends paid.
How Quintarthai uses it
Check earnings, free cash flow, and dividends paid side by side on a company's deep-analysis page (Financials 10-yr and Ratios tabs) to gauge coverage.
Cross-border note. For REITs and many income trusts, common in both Canada and the U.S., earnings-based coverage is misleading because heavy depreciation depresses net income; use funds from operations (FFO) or AFFO instead. Match the metric to the business type before judging coverage.
FAQ
What coverage ratio is considered safe?
There is no universal number, but for typical companies a ratio around 2 or higher is often viewed as comfortable, while below about 1.5 warrants a closer look. Capital-light, stable businesses can safely run lower coverage than cyclical ones.
How does it relate to the payout ratio?
They are reciprocals. Coverage ratio equals 1 divided by the payout ratio, so a 50% payout ratio is the same as 2x coverage, and a 100% payout ratio is 1x coverage.
Check your understanding
A company reports a dividend coverage ratio of 1, meaning earnings just barely equal the dividend. How should an investor read this?
Coverage of 1 means the dividend consumes essentially all earnings, leaving no cushion, so a dip in profits could force a cut; 1x coverage equals a 100% payout ratio, not 50%.