What a dividend payout ratio can (and can't) tell you

A high payout ratio could be a red flag, but it doesn't always portend a dividend cut.

Karen Wallace 25 June, 2018 | 5:00PM

Q: I was looking at the valuations of a few stocks and noticed that  Hanesbrands HBI has a payout ratio of 353%. Does this super-high payout ratio signal that the 3% yield is at risk? And how on earth could the dividend grow if the company is paying out that much more than it's earning?

A: 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" -- 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 to pay out more than it earns indefinitely.

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Karen Wallace

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