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Follow the Cash

A company pays dividends out of the profits or cash flow it generates from operations. Evaluate dividend safety by comparing the dividend rate to the cash available. For corporations, the dividend payout ratio, the dividend percentage to net income per share, is a popular metric. For example, a stock that earned $2 per share in net income and pays a $1 dividend has a 50 percent payout ratio. Companies using tax-advantaged business structures, including real estate investment trusts and master limited partnerships, must pay out 90 percent or more of net income as dividends. For these companies, compare the dividend rate to free cash flow per share. REITs report funds from operations to show the cash available for distribution, and MLPs call it distributable cash flow. FFO and DCF are often much higher than the reported net income per share, providing a margin of dividend safety.

The Yield vs. Growth Spectrum

Buying Dividends for the Long Term

References

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