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Ask a Fool: Are My Dividends Safe?

By Matthew Frankel, CFP® - Apr 13, 2017 at 4:54PM

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Here's how to give your dividend stocks a quick safety check.

Q: I own several dividend growth stocks. How can I tell whether the dividends will keep growing, or if a dividend cut is possible?

First of all, there is no 100% guaranteed way to determine if your dividends are safe. There's always a risk that any company will need to cut its dividend in the future. Having said that, there are a few things to look at that can help you determine if your stocks have a strong probability of growing their dividends.

The first metric you should know as a dividend investor is known as the payout ratio. This is simply the dividends a stock pays out divided by its earnings. For example, a stock that paid out $1.00 per share last year and earned $2.00 would have a payout ratio of 50%. Lower payout ratios mean that the stock earns a lot more than it pays out, so even if earnings were to drop a little, the dividend should be sustainable.

I generally like to see payout ratios under 50% from dividend stocks (excluding REITS, which are required to pay out 90% of their earnings). It's a big warning sign if any of your stocks have payout ratios close to or greater than 100%.

Next, take a look at your stock's earnings history. You don't necessarily need to see growth every single year, just stability and an upward trend over time. The safest dividends come from businesses that do fine no matter what the market is doing.

Finally, look at the company's dividend record. Past performance doesn't guarantee future results, but stocks that raise their dividends year after year tend to continue to do so.

Let's use Johnson & Johnson as an example. The company pays an annualized dividend of $3.20 and earned $6.73 in 2016, for a payout ratio of 48%. The company has also grown its earnings at a very consistent pace, and has increased its dividend, without fail, for 54 years straight. Therefore, I'd say there's an extremely low chance Johnson & Johnson will have to cut its dividend anytime soon.

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Matthew Frankel has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Johnson & Johnson. The Motley Fool has a disclosure policy.

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