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Ask a Fool: Why Did General Electric Cut Its Dividend, and Are My Other Dividend Stocks Safe?

By Matthew Frankel, CFP® - Nov 17, 2017 at 2:01PM

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While there's no way to predict dividend safety with 100% certainty, there are some danger signs to look for.

Q: General Electric just cut its dividend in half. Why would it do that, and how can I tell if my other stocks could do the same?

General Electric (GE -0.74%) cut its dividend in half in order to save money. The company hasn't been making enough money to cover its dividend recently, and the cut will save GE more than $4 billion per year. GE's free cash flow has declined for six years in a row, so cost-cutting measures had become necessary.

There's no way to predict with 100% reliability whether a company will be able to maintain or grow its dividend payments in perpetuity, but there are a few things that can indicate your dividends might be in trouble.

The most important dividend-related metric to know is the payout ratio. This is simply a stock's dividend, expressed as a percentage of its earnings. For example, if a stock pays $0.50 in dividends this year and earns $1.00, its payout ratio is 50%. A payout ratio of 60% or less is generally considered healthy, and 100% or more implies that the stock isn't earning enough to pay its dividend.

In GE's case, the company was paying out dividends at a rate of $0.96 per year, yet it had only earned $0.86 per share over the past year. This is a payout ratio of 112% and was a clear sign to GE's investors that the dividend might be unsustainable.

Other warning signs include declining earnings or free cash flow, a debt load that is rapidly increasing, and a history of previous cuts during a recession. If any of these apply, there's a strong chance that your dividends could be in danger -- especially if the stock has a high payout ratio.

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