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).
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.
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:
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.
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.
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.
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!
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.
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.