Importance of Dividend Payout Ratio

By dividend stocks (Own work) [CC BY-SA 4.0 (http://creativecommons.org/licenses/by-sa/4.0)], via Wikimedia Commons

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I’ve always strongly believed in focusing on return rate solely on dividends when investing since dividend returns are guaranteed if the underlying business is doing well and enforces a shareholder-friendly dividend policy.

Capital gains on the other hand is dependent on whether the stock market thinks it is worth the price (can be “under-valued” for a very long period of time) and has the liquidity to pay for it (bear markets may squeeze out the liquidity of stock market).

That’s why I’ve always focused on stocks that have at least 10 years dividend history growth, since a dividend growth strategy will likely continue if it’s been done for at least 10 years as long as the underlying business can afford the growth. And if an underlying business can grow its dividends for at least 10 years, then more likely than not it must possess some form of economic moat to sustain the profit margins and growth to afford the dividend growth.

This allows me to calculate the return on investment based on a Gordon Growth model since a company with a strong economic moat technically should last until perpetuity, which gives certainty to the baseline dividends paid and the dividend growth rate.

However, a crucial factor I’ve overlooked is dividend payout ratio.

During the 2008-2009 Financial Crisis, the S&P 500 Dividend Aristocrats list dropped from 52 to 42 by 2010 (19.23% decrease). To reduce the probability that the Dividend Aristocrat I’m holding will depart from the Dividend Aristocrats list during the next bear market, close attention must be paid to the dividend payout ratio.

This focus will be reflected on my investment strategy, where I may forgo higher potential growth just so I can confirm the stock has a manageable payout ratio that won’t threaten the dividend yield.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

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