Looking at a company with a nice fat dividend? That’s great. But here’s a a quick reality check to see if that dividend is viable. Look at the ratio of dividend per share to earnings per share. What is this number? In short, it’s the percent of profits the company is allocating to paying dividends to shareholders. The lower the number, the greater the likelihood the dividend is safe. Example: A company pays a $0.90 dividend and earns $1.00 per share. Nine percent of profits are going toward dividends. If earnings dip just a little bit, the dividend is at risk. Compare this to a company that earns $1.00 and pays a $0.25 dividend. Earnings could be cut in half, and there would still be plenty of profits left over to pay the dividend. Is this the only analysis you ever need to do to assess the safety of a dividend? Not, but it’s a good first step.
This article was written with Paul Andrews and published by Barron’s. At the time of publication he was managing director for research, advocacy, and standards for CFA Institute. It was one of several articles we worked on with CFA Institute regarding market integrity and regulation.