Noncash charges, such as depreciation and amortization, can sometimes cause a company's earnings to dip and its payout ratio to spike. A high payout ratio under such circumstances isn't necessarily a warning sign of an imminent dividend cut. That's why it's important to look at the company's free cash flow. Free cash flow represents the cash a company generates from its operations, net of what it spends on its plant and equipment. These are the funds a company can use to pay dividends, among other things. If free cash flow is strong, dividend payments probably won't be a problem for the company, even if earnings stumble in that year.
Philip Morris' free cash flow more than covered dividend payments in 1999. In fact, its free cash flow of $9.6 billion was more than twice what it paid out in dividends, leaving a few billion dollars extra for such possible expenses as lawsuit settlements.
Is the Balance Sheet Healthy? >>