Using payout ratios to evaluate the health of a dividend stock is a quick way for investors to assess if a payout is too good to be true and due for a cut. Anything over 80% will likely raise some eyebrows, and at more than 100%, investors may skip a stock altogether. However, a payout ratio based on profitability isn't always a reliable metric to count on, as some businesses have significant expenses that don't affect cash flow.
Three stocks with payout ratios of more than 100% right now are Viatris (VTRS), Altria (MO 0.12%), and Enbridge (ENB 1.02%). Should investors go for safer options, or are these underrated dividend stocks you can count on for some high payouts? Let's see.
Generic drugmaker Viatris pays an impressive yield of just over 5% right now. That's more than double the S&P 500 average of 1.7%. It would take a $20,000 investment in the stock to generate $1,000 in annual dividend income versus the nearly $59,000 you would need to invest to earn the same amount at the S&P's average rate.
There's definitely an incentive for investors to buy the dividend stock for its high yield. However, its bottom line has been inconsistent, falling in the red in two of the past four quarters. Its diluted per-share profit of $0.14 over the trailing 12 months is nowhere near enough to cover its dividend, which pays $0.48 per share per year.
However, the more important figure for investors to focus on is free cash flow. This year, Viatris projects between $2.5 billion and $2.9 billion in free cash. That is more than enough room to cover its cash dividend payments (they cost the company around $600 million over the course of a year) while also leaving room for Viatris to pay down its debt, which totals more than $22 billion. Plus, the company is selling its biosimilars portfolio for $3.3 billion to Biocon Biologics, which will free up even more cash for the business.
The stock has taken a pounding this year, falling 29% (far worse than the S&P 500's decline of 17%), likely due to its unimpressive results. While Viatris may not be a top growth stock to own, its dividend does look sustainable, and it could make for an underrated buy -- especially since it's already trading at a minuscule forward price-to-earnings multiple of less than three.
Tobacco giant Altria is a Dividend King, and so its track record of consistent payouts speaks for itself. But the past doesn't always predict the future. And the company is facing some serious headwinds as the Food and Drug Administration may end up banning e-cigarette maker Juul, a key Altria investment. In addition, the federal government is looking to limit nicotine levels on cigarettes, which may also adversely impact Altria's business.
These factors could put pressure on the company's bottom line which, in turn, may impact the dividend. At a whopping 216%, Altria's payout ratio doesn't look sustainable at its current levels. Its free cash of $8.3 billion over the past 12 months is, however, more than the $6.5 billion that the company has paid out in dividends during that time.
Altria's stock has fallen 8% this year, proving it to be a more stable buy than the S&P 500. And at 8.4%, its yield is incredibly high. Yet, while it still looks stable right now, investors should be careful here and keep an eye on any further developments because the challenges Altria is facing right now could have lasting impacts on its future and its payouts.
Pipeline company Enbridge is another high-yield stock that may worry investors. At 6.3%, its yield has actually shrunk this year because of how well the stock has been doing. With commodity prices hitting multi-year highs, oil and gas has been a hot place to invest. At a positive 11%, Enbridge's returns this year are the best on this list.
Enbridge is a stock that typically has a high payout ratio, and that's due to the nature of its business. On a quarterly basis, its depreciation and amortization expenses, which don't affect cash flow, total more than 1 billion Canadian dollars. That's more than half of what the company pays in dividends (CA$1.8 billion). This is a key reason why looking at its payout ratio with respect to net income isn't helpful for dividend investors -- Enbridge's payout ratio is in excess of 100%.
Oil and gas stocks often rely on distributable cash flow (DCF), which is an adjusted cash flow number that factors out items such as preferred share dividends and maintenance capital to help evaluate their payouts. This year, Enbridge projects DCF per share of at least CA$5.20. And through to 2024, it expects DCF to grow by an average of at least 5%. With quarterly dividend payments of CA$0.86, Enbridge's dividend looks safe, and the stock could make a great buy right now.