Why Investors Ought to Be Wary of Dividend Payouts in Excess of Earnings

For investors looking to initiate a new position in a company paying a dividend, there can be too much emphasis placed on the underlying yield of said company, at one particular point in time.

This can be a significant potential problem for income-oriented investors, as the dividend payout ratio of any company really only tells one part of the story -- where the company stands today in terms of its dividend payout relative to its stock price (a snapshot in time).

Taking a closer look at how a company’s dividend payout has compared to its earnings, over a long period of time (say, five or 10 years), can provide investors with a more holistic view of how a company’s underlying earnings support said dividend over time.

Many companies chose to keep their dividend payout constant, or raise their payouts over time, while earnings may not follow suit. A periodic drop in earnings relative to a company’s payout in one period is likely not something to worry about; however, should this trend persist over an elongated period of time, investors should worry about the effect of a company paying out more than it makes by a substantial margin.

If a dividend payout appears to be unsustainable based on a very high payout ratio, I would recommend examining the payout ratio over time and determining the viability of said dividend in the future.

A dividend cut, or the ceasing of a dividend, could prove to be seriously problematic for investors from both an income perspective, as well as a capital loss perspective, as investors tend to flee companies that cut their payouts, due to these companies often being viewed as toxic or tainted without a dividend, or with a reduced payout.

Invest wisely, my friends.