The payout ratio is a metric that can be used to assess the sustainability of a stock's dividend payments. In general, a lower payout ratio indicates that a company's dividend has room to grow and could withstand a drop in profits, while a high payout ratio could be a sign of an impending dividend cut.
How to use the payout ratio
While it's certainly useful, the payout ratio doesn't paint a complete picture of the dividend's sustainability. For example, a stock that has a low payout ratio may also have a dangerously high debt load, a business that's vulnerable to recessions, or rapidly rising costs of doing business, all of which could threaten the dividend. As you can see in the chart below, this was the case with oil stocks such as Chevron . As oil prices collapsed in 2014 and 2015, Chevron's sub-30% payout ratio soared to more than 170% as profits fell.
CVX Payout Ratio (Annual) data by YCharts .
The bottom line is that the payout ratio is a great metric to use when evaluating dividend stocks , but it's only one piece of the puzzle that should be used as part of your due diligence before investing. You should incorporate several other metrics, such as these , into your analysis.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
