The payout ratio is a key metric for quickly assessing dividend safety since it indicates what proportion of a company’s earnings-per-share is spent on dividend payments. The payout ratio is calculated as follows:

A low payout ratio, like 50% for a high dividend stock is a positive sign. Stocks with lower payout ratios can potentially continue to pay their current dividends, even if they see a drop in earnings. Furthermore, companies with lower payout ratios do have the possibility to increase their dividend payments over time.

A high payout ratio means that a company is using a significant percentage of its earnings to pay a dividend, which leaves less money to invest in the future growth of the business. A dividend payout ratio over 100%, means that the company is paying out more money to investors than it’s taking in. This isn’t a sustainable model and should be taken as a sign that dividend payments are at risk.

Although a clear threshold cannot be giving, selecting high dividend stocks with payout ratios below 80% is a good practice and often used by investors. Depending on the “personal” risk tolerance, higher risk investors could set a cut-off at 90%, while more conservative investor could set the cut-off somewhere between 50%-70%. One could take into account that dividend payout ratios are also linked to the sectors.

Next, to payout ratio, the price-to-earnings ratio is also widely used by investors as an indicator.

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