You know what a company's payout ratio is, right? It's the percentage of net income a company pays out to shareholders as a dividend. For example, Pfizer
Is that good? Well, there is no exact, perfect payout ratio. But when the number is low, the firm is keeping most of its earnings for other uses, such as reinvesting in the business or buying back shares. Think of Microsoft
Consider pharmaceutical firm Bristol Myers-Squibb
For comparison in the pharmaceutical industry, Merck
Beware of high numbers
There are many lessons to learn about dividends, and Mathew tackles them regularly in Income Investor. The examples above also offer a few. For starters, don't fall for the fattest dividend yield you can find. Since the yield is calculated by dividing the annual dividend by the current stock price, if the stock price falls, the yield rises. So a company in trouble may have a hefty yield -- at least until it reduces or eliminates its dividend.
Similarly, a high payout ratio is cause for concern. For example, Citizens Communications'
Find the best bets
So choose your dividend-paying investments carefully, my friend. And if you'd like some help zeroing in on healthy, growing companies that pay significant dividends, give our Income Investor newsletter a whirl. You can try it for free for a whole month, with access to all past issues, special reports, and Mathew's complete list of recommendations. In two and a half years, Mathew's picks have averaged a return of 18%, vs. 14% for the same amounts invested in the S&P 500. Fully 18 of them sport current dividend yields above 5%, and ten top 7%.
Here's to a hefty income in your future!
(Consider forwarding this article to anyone you care about. Just click on the "Email this Page" link near the bottom of the page.)
Selena Maranjian owns shares of Microsoft and Pfizer. For more about Selena, view her bioandher profile. Merck, Eli Lilly, and Citizens Communications are all Income Investor recommendations. Microsoft and Pfizer are Inside Value picks. The Motley Fool isFools writing for Fools.