Hello, Fellow/Future Investor!
Some people may be under the impression that if they find a stock that pays a very high dividend, their work is done. They can just buy it and live happily ever after collecting “hefty dividends”.
However, approaching dividend stock purchases in such a manner can be a big mistake.
Before I explain why, here’s what you should know: The “Dividend Yield” is another name for the interest payments a company would pay YOU simply for owning their stock. Payments are typically issued quarterly (every 3 months).
Here is an example of where to find the Dividend Yield for a particular company and what the data looks like. I grabbed the screenshot from Yahoo Finance:
The % you see (2.47%) is the yield (or the “interest payment”) paid to shareholders (people that own that stock). The dollar amount you see ($5.44) is the same information, just in dollar terms.
And so, people that own shares of this stock get $5.44 per share over the course of a year.
Now that we have that clear, keep this in mind:
A high dividend yield should never be your sole determining factor when researching dividend paying stocks.
The truth of the matter is, there are several factors an investor should look into when researching a prospective investment that pays a dividend.
One of those important factors is the company’s Dividend Payout Ratio.
The Dividend Payout Ratio (also known as ‘DPR’ or ‘Payout Ratio’), is simply a metric that tells you what is the percentage of profits a company is paying out in dividends to their shareholders.
Ideally, dividend payments come from the profits a company generates – what is left over after all expenses are taken care of.
A company can choose to keep those extra funds and invest them back into the business and/or they can compensate shareholders in the form of dividend payments.
Here’s an example:
The image below shows the dividend-data information for a specific company. The circled number tells us the Payout Ratio is 54.82%.
Here’s what the number means:
A Payout Ratio of 54.82% means the company pays out 54.82% of its profits in the form of dividends and keeps 45.18% (100-54.82=45.18) inside the company in order to invest in projects, products, or services that can help the company remain strong and competitive.
Now, let’s look at another example:
Let’s say you are looking into the dividend payout ratio of a different company. You notice that their ratio is at 110%.
A Dividend Payout ratio that is OVER 100% means that the company is likely incurring debt in order to pay dividends.
If you really like the company, you’ll need to take your research a couple of steps further. You’ll need to investigate if the debt is manageable and if the company is financially healthy to pay it off.
Finding out that information can help you analyze whether or not the dividend payments are sustainable or whether they’ll stop paying them at some point in the future.
This situation would be a red flag worth looking further into before buying the stock for the purpose of dividend payments.
Now, you may be wondering what percentage would be considered ‘reasonable’ for a Dividend Payout Ratio. Generally speaking, a ratio of about 70% or lower is considered a healthy ballpark by most stock analysts.
However, it is also important to note that you may notice that older, more mature businesses may have ratios in the ballpark of 80% or higher in some cases.
This is usually normal. Think about it – an older, more established company doesn’t have to invest a lot of money in growth and development so, they get to pay out more to investors.
With that said, remember that every company is different and you have to take a very close look at the business as a whole when you are examining Payout Ratios.
And this is it for today’s post! As a mini homework assignment, I challenge you to find the dividend payout ratio of a company you might be interested in and let me know what that is in the comments.
Take it one step further and tell me what you can conclude from the number that you see in your research.
Have a fantastic week! Cheers to profits.
Interested in learning more about Dividends? Check out our highly rated class which teaches you how to make EDUCATED investing decisions around dividend stocks and how to become a Dividend Investor. The class includes a Dividend Guide which lists (in detail) my top 10 favorite dividend-paying stocks. To learn more and enroll, click here.
The class also takes the above lesson a step further and explains the other metrics you should be looking into in order to make EDUCATED dividend-stocks decisions.
New to investing? Check out this resource:
Understanding Your Investing Options: Step by Step Guide for Beginner Investors – new to investing and not sure where to begin and/or feeling overwhelmed with all the options available in this day and age?! This guide is for you. Check out details here.