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What a Dividend Payout Ratio Can (and Can't) Tell You

To consider the ratio in the context of how volatile a company's earnings tend to be, as well as the financial strength of the company

Karen Wallace 08 March, 2017 | 15:23
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In a recent article exploring the valuations of stocks in the Morningstar Dividend Yield Focus Index, a few readers wondered whether Pfizer's seemingly very high payout ratio signals danger for the company's dividend. One reader asked: "[Pfizer's] payout ratio seems high at 1.18. This puts the 3.8% yield at risk. It is still a very good company and well run. My question is, what is a realistic yield in the future, 2%-3%?"

The payout ratio is a very useful metric for evaluating a dividend-paying stock. The calculation is simple enough: It's the proportion of a company's earnings paid out as dividends.

A lower payout ratio can sometimes indicate that the dividend is "healthy"; in other words, there is a margin of safety that would allow a company to miss its earnings target and still be able to pay out its dividend, and there may also be room for management to increase the dividend over time. A payout ratio over 100 may indicate that the dividend is in jeopardy, because no company can continue pay out more than it earns indefinitely.

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About Author

Karen Wallace  Karen Wallace, CFP® is Morningstar’s director of investor education.

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