Dividend Income Guide
Dividend glossary

Dividend Coverage Ratio

Dividend coverage ratio measures how many times over a company could pay its current dividend from its earnings or free cash flow. A ratio above 2.0x is generally considered healthy.

In more depth

Dividend coverage ratio is the inverse of the payout ratio. A coverage ratio of 2.5x means the company earns 2.5 times what it pays in dividends — substantial buffer for maintaining the payout during a business downturn.

The formula

Dividend Coverage Ratio = Earnings Per Share (or Free Cash Flow Per Share) ÷ Dividends Per Share

Example: A company earns $4.00 per share and pays $1.60 in annual dividends. Coverage ratio = 4.00 ÷ 1.60 = 2.5x.

This is equivalent to saying the payout ratio is 40% (1.60 ÷ 4.00 = 40%). Coverage ratio and payout ratio are two ways of expressing the same relationship — one from the company's perspective, one from the dividend's perspective.

What coverage ratios mean in practice

| Coverage ratio | Interpretation | |---|---| | Below 1.0x | Dividend exceeds earnings — unsustainable without additional cash sources | | 1.0x–1.5x | Thin coverage — dividend vulnerable to any earnings decline | | 1.5x–2.0x | Adequate coverage for stable businesses | | 2.0x–3.0x | Healthy — good buffer for earnings fluctuation | | Above 3.0x | Very strong coverage — substantial room to raise the dividend |

Industry variations

Like payout ratio, coverage ratio norms vary by sector. REITs are measured using funds from operations (FFO) coverage rather than earnings. Utilities with highly predictable regulated revenues can sustain lower coverage ratios than cyclical manufacturers.

Related terms

  • Payout ratio — the inverse of coverage ratio, same information different frame
  • Free cash flow — often a more reliable denominator than earnings
  • Dividend safety — composite assessment that uses coverage ratio as a key input
← Back to glossary