Whether a dividend is safe is, almost always, two ratios. The payout ratio based on accounting earnings is the textbook answer and the one most retail investors stop at. The harder, more honest test is FCF payout ratio — the dividend as a fraction of free cash flow. When the two diverge, trust the cash one.

Two Coverage Ratios, One Decision

DPS / EPS
Payout ratio (accounting)
Dividend per share divided by earnings per share. The textbook number. Rule of thumb: < 60% comfortable, 60-80% tight, > 80% at-risk. Easy to compute; easy to manipulate (because EPS is itself manipulable).
DPS / FCF
FCF payout ratio (cash)
Dividend per share divided by free cash flow per share. The honest number. FCF cannot be window-dressed the way EPS can. Rule of thumb: < 50% comfortable, 50-75% tight, > 75% at-risk.

Why FCF Payout Is the Harder Test

EPS includes a long list of non-cash and adjustable items — depreciation, stock-based compensation, deferred taxes, restructuring charges, amortisation. A company can report comfortable earnings while burning through cash. Free cash flow is much harder to fake: it's operating cash flow minus capital expenditure, and dividends are paid from it.

The pattern to watch: a company with a healthy 50% accounting payout ratio but a 90% FCF payout ratio. The dividend is being maintained from accounting profits while cash is going out the door. Sustainable for a year or two; not sustainable for five.

Dividend cuts are almost never about a single bad year. They are about cash coverage that has been quietly deteriorating for 3-5 years while accounting earnings stayed cosmetically fine. The leading indicator is FCF payout ratio creeping above 80%; the lagging indicator is the cut announcement.

The 5-Year Coverage Trend

For any dividend stock you are evaluating:

  1. Pull 5 years of dividends paid, EPS, and FCF per share.
  2. Compute both payout ratios per year and plot the trend.
  3. If the FCF payout has trended up for 3+ years and crossed 75%, the next dividend is being financed by something other than current operations — debt, asset sales, or a one-time event.
  4. Cross-check with debt growth. If debt is growing while FCF payout is rising, the dividend is being borrowed. That is the loudest warning sign on the page.

Two ratios, one decision: EPS payout (textbook) + FCF payout (honest)
FCF payout > 75% trending up = next year's cut is the leading indicator now
Debt growing alongside rising payout = the dividend is being borrowed

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