Dividend Payout Ratio

With individual stocks, figuring out the viability of a dividend requires looking at different metrics. A key one is the dividend payout ratio, which measures the past 12 months of dividends relative to earnings. The higher the ratio of dividends to earnings, the more likely a dividend is unsustainable.

The good news is that most stock payout ratios are currently low by historical standards. "Right now the S&P 500 is at a 36 percent payout ratio in terms of earnings," says Diane Jaffee, manager of the TCW Relative Value Dividend Appreciation Fund. "Historically, that number's been about 50 percent. So we think the average S&P stock has more room to grow its dividends."

That said, Jaffee notes that the highest yielding sectors -- consumer staples, utilities and telecommunications -- have much bigger payout ratios.

Instead of seeking the highest dividends, Jaffee prefers stocks with strong cash flows and low payout ratios. She points to tech company Cisco Systems, which has a 3.1 percent dividend yield. The company has a payout ratio of 33 percent and has tripled its quarterly dividend in the last three years, to 19 cents a share. Jaffee thinks its current dividend has more room to grow, upward of 5 percent a year over the next three years.

In other words: if a company or fund's dividend yield seems too good to be true, it probably is.

The opinions expressed here are those of the author, a columnist for Reuters.
 

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