What is a Good Dividend Payout Ratio?

While some industry experts discount the relevance of a dividend payout ratio, many investors find this information critical in the stock selection process. These ratios vary per industry and can be affected by different tax laws or market conditions. In addition, a high payout may not always be a sound financial investment. A company that is growing and poised to explode may pay very low dividends in order to generate higher returns and higher stock prices. Alternately a company with a high dividend payout ratio may have stock that is temporarily depressed.

When a Low Dividend Payout Ratio is Good

Finding a company that has a low dividend ratio is important to many investors. During tough economic times a company that has a low dividend payout ratio is more likely to survive an earnings decline. In addition, there is a good chance that the company will be able to maintain their current dividend rate. Finding a good dividend payout ratio also means that the money is reinvested into the company.

Why a Low Dividend Payout Ratio is Bad

However, a low dividend payout ratio may also indicate that a company is struggling and is unable to pay more to investors. In this scenario, a low dividend payout ratio is bad. Some companies need to borrow money in order to continue operating and pay dividend payouts based on credit. It is important to make sure that they have enough assets to cover their total assets before investing to ensure a good dividend payout ratio.

Why a High Dividend Payout Ratio is Good

Other investors want a short term, high dividend payout from companies who offer from 80-100 percent returns. In addition, there is the argument that with higher earnings growth, share prices will rise which is sure to be better for investors. Many companies use their stock profit payments in repurchasing stock. In a down economy, repurchasing often destroys value of the stock however. By returning investment profits to the investors, it can prevent this problem from happening and still increase the value of the stock.

Why a High Dividend Payout Ratio is Bad

If a company pays over 100 percent it may seem like a good dividend payout ratio. However, this is not sustainable over the long term. In a short term investment, this might be a smart financial move. Over time though, a dividend growth rate must be sustained by a stable payout ratio. Often when dividend payouts are high, companies need to cut the price. This often demonstrates a lack of confidence by the board of directors about future earnings and investment prices drop as stocks are dumped.

A good dividend payout ratio is an important gauge on how a company is doing financially. Before investing, determine what the dividends are and how sustainable the payments will continue to be. In addition, it is crucial to look at financial goals before making an investment. A short term investor will need to choose different companies from a long term investor. Also be sure to look at the company’s financial statements in order to ensure a solid business model.