If you only check one number before buying a dividend stock, make it the payout ratio.
Payout ratio = dividends per share ÷ earnings per share
If a company earns $4 a share and pays $2 in dividends, its payout ratio is 50%. It keeps half its profit to reinvest, pay down debt, or cushion a bad year.
| Type | Comfortable range |
|---|---|
| Most companies | Under 60% |
| Utilities (stable, regulated) | Under 75% |
| REITs | Use AFFO (adjusted funds from operations) instead of earnings; under ~85% |
Above 90% means almost everything goes out the door, so one bad year can force a cut. Above 100% means the company is paying more than it earns, usually from debt or savings. That can't last.
Earnings are an accounting number; dividends are paid in cash. Also look at the free-cash-flow payout ratio (dividends ÷ free cash flow). Under 70% is a good sign.
A temporarily high payout ratio during a one-off bad year isn't automatically a red flag if the business is recovering. A steadily rising payout ratio over several years, while earnings shrink, is the classic warning sign before a cut.
Payout ratio is one of seven checks worth running: free-cash-flow payout, growth streak, dividend growth rate, debt, yield versus its own history, and the earnings trend.
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General education, not investment advice.