Dividend Stocks

Investing In Stocks For The Sake Of Cash Flow

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The Dividend Payout Ratio

Posted on | May 24, 2011 | Comments Off

The dividend payout ratio is an important indicator when evaluating stocks for your long-term dividend portfolio.  The ratio shows you how much of a company’s earnings are being paid out via dividends.  As we discussed with MLPs, this ratio is very high.  The typical corporations you research as potential stock plays, however, can be all over the map.

A younger, growth company typically will have a very low dividend payout ratio (or maybe even a zero ratio) since they are typically using the earnings to fund future growth.  Even large companies like Berkshire Hathaway (BRK-A) don’t pay a dividend meaning their ratio is a zero also.

Often times as a company matures, and fewer growth prospects present themselves, the dividend payout ratio will increase as they will shift more of their earnings or net income to distribute back to shareholders.

A sweet spot in dividend investing is to find a quality, defensive company with an above average yield, but still with a relatively low dividend payout ratio meaning they will have plenty of room to increase the dividend in the years ahead even if earnings growth is flat.

An overly high dividend payout ratio is sometimes a red flag as it means any dent into future earnings could put future dividends at risk.  Most companies we look at here have modest dividend payout ratios and stable earnings so the future dividends are not at risk.  It is indeed an important indicator to research when evaluating potential stocks.