So, when looking in to dividend-paying stocks is a smart idea to take your research a little further and also look in to their dividend payout ratio.
1. What’s a dividend payout ratio?!
Well, remember that dividends come from earnings that a company has and wants to “share” with its shareholders in the form of payments every quarter. Well, lets say that a company “pays out” 100% or 110% of their earnings in dividends. Wouldn’t that scare you a bit? Well, it should make you raise an eyebrow!
At the very least it should be a red flag for further research on what exactly may be going on behind the scenes.
2. So why should I care that a company wants to give up all their earnings to their shareholders?
Well, a company should have a “balance” on what it does with its earnings. It should set money aside for dividends by all means (we all know I am a huge fan of that!). However, they should also be setting aside part of their earnings for investments that can enhance the value of the company and keep it competitive. For example, they should be investing in research for development of new products, advertising, reserving some money for future expenses and/or investments, etc. I would be a little terrified if a company gives up ALL the money that comes in. Also, let’s say they are paying out a percentage larger than their earnings this can imply the company is borrowing money (ie: taking out loans) to pay dividends. I don’t know about you but that would make me a bit uncomfortable. I’d be wondering where the future of that company is going and you better believe I’d be doing further “homework” on the stock!
Keep in mind that this is a general idea. Some older/more established companies may have a higher dividend payout ratio than others. Hence, if you are looking at a solid company that has been around for generations it might not hurt that they pay out more in earnings than others. One of the reasons being is that they may not have to invest as much to “grow” or “maintain” the company in comparison to a newer corporation. As I always say, just do your research!
3. So, what’s a healthy dividend payout ratio?
Well, there is probably a plethora of opinions about that but, as a general rule, a healthy percentage should be no more than 60% of earnings to be paid out to shareholders. Anything significantly above that should be a red flag for further research to see if that’s really a company you want to invest in for the long term.
4. How do I find out a company’s dividend payout ratio?
Another great question for Yahoo! Finance. Just go in to the site, type in the ticker symbol for the company you are interested in. For this particular example lets use Coca Cola (KO). Then, on the left side of the page click on “key statistics”. (Using KO, coca-cola, as an example on this one).
Subsequently, turn your attention to the lower right hand corner of the page and you will see a box with multiple ratios. One of them being the “payout ratio”.
And there you have it!
If you love math (and have time to spare) you can also calculate it yourself by using either one of the following formulas:
Yearly dividends per share/Earnings per share
Dividends/Net Income Yearly dividends
*But, who has time for that?! Gotta’ love sites that save us time! Technology and free information is quite awesome!
Additional info to keep in mind:
1. A company that pays dividends usually attracts more investors and hence, increases the demand for it. Hence, this is a good thing for people that already own shares as we all know what usually happens when that occurs: the stock appreciates in value!
2. Conversely, when a company decides to lower or eliminate paying dividends all together this hurts its popularity and its value in the face of existing and/or prospective investors whom might be tempted to sell the position (lowering the value of the stock). Something may be going on behind the scene. Hence why is so important to keep a close watch on your stock portfolio at all times and remain informed on whatever may be going on.
Thanks for reading! And until next time! Any questions, you know what to do. Comment below or email me.