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Teaching my kids – Part 14: Payout Ratio

Another post in my Teaching my kids series – The Payout-Ratio

As frequent reader of my blog post you know that I’m writing some posts to try to educate my kids. I know they are still very young (6 and 8) but it is never too early to start. And they can read these blog posts later on in life 😉 (This is probably the case, because they don’t speak or read English very well at this moment – You got to love an understatement!).

This is another blog post to keep the “snowball of knowledge” rolling.

I think when you educate kids about money, they will benefit from it for the rest of their lives. Or as the saying goes: “What is learned in the cradle is carried to the tomb”. And to educate your kid is your responsibility as a parent.

This blog post is a post for my kids when they are a little bit older. I did not talk to my kids about this subject (yet).

 

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Pollie-Code

Before I purchase a stock I do a lot of research and data mining. I try to do this systematic and in the same manner for every stock. So every time I buy a new company I’ll use my Pollie-Code to screen the stock. The Pollie-Code is my basic stock screener to help identify undervalued dividend growth stocks. In my experience it is very helpful to have a consistent code to apply to all stocks. Once a stock passes The Pollie-Code, I’m getting excited and start some further digging/analysis and maybe buy the stock.

One of the metrics of my Pollie-Code is the Payout-Ratio. In this post I’ll write down my vision on the Payout-Ratio.

 

Payout-Ratio

The payout ratio is a very useful metric for evaluating a dividend-paying stock. The calculation is very simple: It’s the proportion of a company’s earnings paid out as dividends.

 

Payout-Ratio = Annualized dividend per share/ Current calendar year EPS

The payout ratio can tell you a lot about a company’s ability to continue paying and possibly grow its dividend. And you can find all different kind of payout-ratios. If we look at dividend growth stocks I distinguish four categories:

 

Nice

I consider a payout-ratio below 40% as a nice ratio. These stocks normally haven’t paid dividend for a long time or just started to. A nice example is Apple ($APPL). These can, if they continue to pay out and raise their dividends, be the future Dividend Aristocrats.

 

Healthy

I consider a range of 35% to 55% as a healthy ratio. You can say that these kinds of companies are well established. Besides paying dividend they also reinvest half of their earnings for growth. And that is what I like to see, because I want my dividend to grow every year. These stocks are in my opinion good stocks for DGI’s.

 

Still Okay

Payout ratios that are between 55% to 75% I consider them as still okay but need some extra attention. When a company is expected to distribute more than half of its earnings as dividends, they have less money to reinvest for earning growth. So the risk of cutting the dividend is a little bit higher.

 

Too high

A payout ratio higher that 75% is in my opinion too high. For a company to maintain these kinds of dividends they have to work very hard. And as a DGI, I want growth in my dividend, so a company also has to grow their earnings. This together is very hard. And therefore the risk of the company cutting its dividend is high. That is something I do not want!

 

Conclusion

As a Dividend Growth Investor I always prefer healthy payout ratios over too high payout ratios (Duh..). And as mentioned above, a too high ratio may be attractive in the short term, but they may not last. So be careful with these kinds of companies.

I think that the payout ratio is a very useful tool and an important metric in the Pollie-Code. But is not the only metric in the decision-making.

 

Finally

This is my fourteenth blog post about teaching my kids. I hope my kids at the age of say 18, have all the financial knowledge I’m having right now. This would be a huge advantage for them! And that’s why I started these blog post series.
What do you tell your kids about money and investing? And do you have a suggestion about a new addition to this series? I like to hear from you!

Help me get the “snowball of knowledge” rolling and share this post.

Cheers,

Pollie

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4 thoughts on “Teaching my kids – Part 14: Payout Ratio

  1. Duncan's Dividends

    One of the things I put a post about was about starting an IRA as soon as they start making money. Socking away funds when you are 16 gives you a heck of a head start against your peers if you can do it.

    1. Pollie Post author

      Thanks for the suggestion! The power of compound interest!
      I wrote about this subject already. And working on a new post on starting early.

      Cheers,

      Pollie

  2. Team CF

    A notable exception are the pay-out ratios for REIT’s and utility companies. These are generally high, but as either the result of regulations (for some REIT’s) or the nature of the business (i.e. the utility companies). Mind you, some of these are not really dividend growth shares, but steady dividend payers.
    Love this series Pollie, keep it up!

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