Having an investment that yields dividends provides additional value to the shareholder. These payments represent a portion of company earnings approved by the company board of directors to be paid to investors. The percentage of earnings paid to these investors as dividends is called the dividend payout ratio.
The dividend payout ratio can be calculated by dividing the annual dividend per share by the earnings per share. Alternatively, the same figure can be arrived at by dividing the dollar amount of dividends by the net income of the company. This ratio provides a way to assess how well company earnings support dividend payments made. More mature companies usually have higher dividend payout ratios.
An analysis of this ratio allows an investor to identify companies with sufficient internal growth to permit annual increases in dividend payments. Receiving increasing dividend payments each year allows the income from the investment portfolio exceed the rate of inflation. This will provide a larger income during the retirement years.
Investors should consider stocks with dividend payout ratios between 40 and 60 percent. This range represents a decent payout to investors and an adequate amount of money being reinvested in the company, spurring internal growth. This growth will permit the increasing dividend payments previously mentioned.
Though an investor may be tempted to invest in companies with high yielding dividends, they should avoid this urge. More money paid to investors equates to less profits being reinvested in the company. A dividend payout ratio may increase during a turbulent economy because it would be detrimental to the stock to lower the dividend. However, ratios over 100 percent will be difficult for a company to sustain and can hinder business growth. Investors should figure out the dividend payout ratio and invest in only those companies that seem able to sustain and increase dividend payments.
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