If you want to be sure your investment can keep paying you a dividend, then you need to be able to calculate its dividend payout ratio.
After all investing for income is a wonderful thing. It’s what gives you the freedom to enjoy your life. It can supercharge your retirement savings and more importantly, income is what you need for you and your family to live comfortably.
And dividends are the stockmarket’s best source of passive income. Dividends are the “reward” you get for investing in stocks. And they’re vital to overall performance of your portfolio. So how can you check if your investments can sustain their dividend pay-outs?
It’s called the “dividend payout ratio.”
By definition, it’s the percentage of earnings the company pays out as dividends, usually on an annual basis.
But as an investor, what you’re looking for in a dividend payout ratio is sustainability.
For example, a dividend payout ratio of more than 100% is usually not sustainable.
At that pace, the company will eventually run out of money.
Likewise, a low dividend-pay-out ratio suggests the company isn’t returning much money to shareholders.
A sustainable pay-out ratio should be higher than 30% but no more than 60%. This suggests the company pays a generous dividend and still has breathing room in the case of short-term market fluctuations.
Where can you find the dividend payout ratio
You can find this one number when a company releases its financial statements.
Or to work it out is very simple: If a company reports earnings of 50c and dividends of 25c, its dividend pay-out ratio is 50% ((25c/50c)*100).
The bigger the gap between a company’s dividend and its earnings, the better the chance the company has of maintaining its dividend, if earnings come under pressure.
As earnings can sometimes be manipulated through the issuing of new shares, another way to work out dividend pay-out ratio is to use free cash flow per share. The more cash a company generates, the greater the likelihood it will pay-out dividends.
One of the reasons my Real Wealth portfolio has consistently outperformed the JSE All Share performance by more than double over the last 12 years is because a portion of our portfolio allocation is dedicated to exactly these kind of dividend paying stocks.
I call them Dividend Dominators.
And every year, I release my top five for readers to add or rebalance their portfolio.
If you’d like to claim a free copy of my Top Five Dividend Dominators, then join my Real Wealth community on a no obligation trial.
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