Dividends at Risk
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When an investor is looking at companies with huge track records of increasing dividends, such as Coca-Cola or Procter & Gamble, then the concept of Dividends at risk does not seem to come up very often. However, I believe an investor should always have this concept in the back of their mind and be on the lookout for signs that their company is not in this boat.
How do you know if a company’s dividends are at risk. The first place to look is at the Dividend Payout Ratio for the company. However, when you are looking at the number, do not assume that just because the number is high, that that is an issue for the company. Of most important is looking at the Payout Ratio over time to see where the trend sits. For example, if the dividend ratio for a company currently sits at 62%, and looking back over the past 5-10 years it has been in a range from 55 – 65%, then I would say there is nothing to worry about at first glance. However, if all of a sudden the payout ration went to 75% then it means that you as an investor need to figure out why. As the payout ratio is calculated using the dividend per share and the earnings for the company, it means something drastic has happened to the earnings. You will need to find out what and make your decision on next steps based on that data.
This is only the first place to look – an investor should also be looking at things like free cash flow trends and common areas such as revenue growth. A drastically different payout ratio only tells you of other things that are going on in a company and should not be looked at in isolation.
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Bob said:
Where can I get the Dividend Payout ratio from and also the history of the dividend payout ?
July 27th, 2007 at 9:05 am
[...] The Dividend Guy tells us how to identify a company whose dividends are at risk. [...]
[...] Dividends at Risk [...]
[...] I like this as it is simple and covers the basis for what would constitute a strong dividend stock: a record of dividend increases over time, a good dividend growth rate, a good payout ratio, and solid earnings. One comment I would add with respect to the payout ratio is that the payout ratio for a company should be looked at over a time period. A steady payout ratio is good to see, where as a increasing payout ratio is not as good as the company’s earnings may not be keeping up with dividend payments. This ratio cannot be looked at as a snapshot in time, but should be viewed over a period of time. Please see this post for more of my thoughts on this. [...]