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How to check how safe your dividends are

by , 20 May 2015

If you invest for income, you want to know about dividend safety. When a company cuts its dividend, the income from your portfolio will fall.

So how can you check dividend safety?

Read on to find out…

When it comes to dividends don’t worry about earnings

Earnings aren’t always as they appear to be. Company management can push numbers about to make sure that the revenue recorded is the most beneficial.

For instance, if a company is on track to meet its forecasts and secures a big contact just at the end of its financial period, it could hold off putting this information through until the start of the next period.

Earnings don’t always tell the full story. That’s why you shouldn’t focus on earnings when thinking about dividends. Instead you should look at cash flow.

Using cash flow when checking dividends

Cash flow is all of the cash that goes in and out of a company. Dividends come from a company’s cash, not its earnings.

Cash flow gives you a much clearer picture of what’s going on. And this is vital when checking dividend safety, Marc Lichtenfeld in Investment U explains.

You can use the cash flow to calculate a company’s dividend pay-out ratio.

Most analysts use earnings to calculate this, but cash flow is a far better figure to use.

You can calculate the dividend pay-out ratio using this equation:

Dividend pay-out ratio = Dividend per share / cash flow per share

This gives you a more accurate way of judging whether a company can pay its dividend.

Ideally, look for a dividend pay-out ratio of 75% of less. If it comes out above 75%, a dividend cut may not be around the corner, but keep a close eye on what’s going on at the company.

So there you have it, how to check how safe your dividends are.

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How to check how safe your dividends are
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