Dividend cover is the opposite of dividend payout ratio and measures the proportion of earnings that the corporation pays out as dividends.  It’s calculated by dividing earnings per share (EPS) by dividends per share (DPS).

Like dividend ratio, you may think that the higher the dividend cover the better.  After all, the more of a company’s earnings it pays out as dividends the better right?

For the very short term you could answer that question “yes” but, for time frames beyond one year, you have to think about the sustainability of the dividend payments.  A company that consistently pays out the majority of it’s earnings as dividends (a dividend cover close to one) won’t have much money left over for growth or to weather tougher economic times.

Although dividend cover is certainly an important ratio to get a snapshot of the dividend policy of a particular stock, it alone is not a great measure of the long term potential of owning the stock.  Better metrics for dividend health are a long history of paying significant dividends, dividend growth over time, and earnings per share growth over time in line with dividends.  After all, if earnings aren’t growing enough to keep up with growing dividends it can only be a matter of time before the dividend is cut.

Many online dividend stock screening tools will show the dividend cover ratio as part of their data.  If they don’t, just take the dividend payout ratio and divide it into one.  One divided by dividend payout ratio equals dividend cover.

So why is it called dividend cover ratio?

By dividing EPS by DPS you get a measure of how many times the dividend is “covered” by the earnings.  A dividend of $0.25 per share for a company with $4.00 earnings per share is a dividend cover of $4.00 / $0.25 or 16.  That means this company’s earnings can cover the dividend 16 times.

What’s a good dividend cover?

That depends on the industry or market sector to which the corporation belongs and a wide variety of market factors that make this ratio difficult to compare across different industries.  Your best bet is to look at several companies in the same sector who are competitors to each other and compare their dividend cover to get an idea of what ratio you should expect for companies in the sector. The healthiest companies with the longest track records of consistent and growing dividend payouts and earnings per share will be those you’ll look to for what a good dividend cover is for that industry.