Dividend Payout Ratios - Dividend Investors Should Look for Healthy Ratios Over High Ratios

Dividend payout ratio (DPR) is not the first thing an investor will look at when choosing a stock.

However, DPR should not be overlooked as it is an important aspect of dividend investing.

It's critical that dividend investors understand this during the coronavirus pandemic.

Related post:Coronavirus: future predictions on how it will change the world forever.

Let's discuss what dividend payout ratios are and why they are so important to dividend investors.

What is a dividend payout ratio?

The dividend payout ratio (DPR) is the total amount of dividends paid to the shareholder in relation to the company's net profit. DPR shows the percentage of profits paid out as dividends.

The amount of income that is not paid out to shareholders in the form of dividends is retained and used for sharesbuy back, reinvestment in the business, debt management and for business operations.

Actually,the dividend rate is an indicator of how much of the net income is paid out in the form of dividends.

Why is the dividend payout ratio important? Tip: Ensure sustainability

Most dividend investors can handle onemarket correctionwithout even hesitating. We simply do not get carried away by market fluctuations, because dividend investors are long-term investors.

But what scares dividend investors isthe possibility todividend cuts, because it affects our turnover.

Related post: March 2020 Dividend Stock Income Update - New Record + 52% YoY Growth

Briefly,a company with a healthy dividend payout ratio is much less likely to experience a dividend cut because they have the cash flow to make the payments to shareholders.

What does DPR tell us about a company?

If a company does not pay out some of its profits in the form of share buybacks or dividends, it is likely a growth company that is reinvesting most of its profits.

So the dividend payout ratio can tell us important information about the maturity of a company.

A growth company, for exampleTeslawill not pay dividends because they want to grow the company as quickly as possible. They put most of the profits back into the company instead of paying out the profits to the shareholders. They do this because the money is better in their hands than in the hands of the shareholders. By reinvesting the profits, the company will grow faster.

An alternative is a company likeAppelInc. has reached a more mature stage. In return, they have more cash flow to reinvest profits while still paying a dividend.

"Behind every stock there is a company. Find out what it does." -Peter Lynch

How to calculate DPR

The formula for calculating the dividend payout ratio is very simple. However, it is not absolutely necessary to know how to calculate the ratio as many sites like thatochtendster.cawill calculate it for you.

Nevertheless, the formula for calculating the dividend payout ratio is as follows:

Dividend rate = dividend paid/net income

On a per-share basis, the calculation looks like this:

Retention ratio = Dividend per share/EPS

* EPS = profit per stock

What is an ideal dividend payout ratio?

According todividend.com,an ideal dividend payout ratio is between 0 and 35%.

Companies within this range are considered healthy because they have more than enough cash flow to cover and grow their dividend payments.

A good example of a healthy company in this area is Apple Inc. According toochtendster.caApple's payout ratio currently stands at 24.38%.

On the other hand,high payout ratios are 55% or more.Although a payout ratio of 55% is not a cause for concern as many established companies maintain a dividend payout within this range. However, a payout ratio of 55% or more could be a sign that the dividend payment is in jeopardy. After all, a company with such a high ratio pays out more than half of its profit. What happens if a depression comes and incomes drop? The company may not be able to maintain its dividend, which is dividend investors' worst nightmare.

An example of a stock with a high dividend payout ratio

Simply put, high dividend payout ratios are a sign of poor management.

When it comes to risky dividend payments, one company in particular stands out to me: Sir Royalty Income Fund (SRV.UN). They are a restaurant holding company that owns and operates a portfolio of restaurants in Canada.

They have been a fantastic dividend stock in recent years. In fact, SRV.UN paid a dividend of more than 8% for years. But sherecently cut their dividend, because their dividend payment exceeded their net income.

Since the dividend cut, they still have a dividend payout ratio of over 85%, according to Morningstar.

This is alarming considering they are in the restaurant industry, which is largely closed due to Covid-19.

Related post:The silver lining of CoviD-19

They recently suspended their dividend and the stock lost more than 50% of its value.

This is the perfect example of why a high dividend payout ratio can be a bad thing.

Meanwhile, lower-yielding stocks like Apple Inc. can easily afford to continue paying their dividends.

Final thoughts on dividend payout ratiosS

Possibly,sustainable, healthy dividend payout ratios are superiorto high payout ratios.

High payout percentages can be tempting in the short term. But dividend increases will be less consistent and there is a greater chance of a dividend cut.

Therefore, it is best for long-term dividend investors to go it alonethe best quality dividend stocks with the healthiest payout ratios.

Decades of sustainable dividend payments and dividend increases will lead to prosperity. Stocks with low growth, high payout ratios, and poor management will not build wealth.

Sources:Dividend.com,Investopedia,Morningstar.ca.

I am not a licensed investment or tax advisor. All opinions are my own. This message contains Google Adsense advertisem*nts. This post also contains internal links, affiliate links, links to external websites and links to RTC social media accounts.