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By Josh Peters, CFA and Jeremy Glaser | 10-27-2015 11:00 AM

The Most Important Statistic for Dividend Investors

Payout ratio--the dividend rate divided by earnings--can give you an idea of how well covered the dividend is, and how likely it is to grow, says Morningstar's Josh Peters.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Josh Peters--he's the editor of Morningstar DividendInvestor newsletter and also our director of equity-income strategy. He recently said that the payout ratio is the most important statistic for dividend investors, and he's here to explain to us why.

Josh, thanks for joining me.

Josh Peters: Good to be here, Jeremy.

Glaser: Let's start with just a definition of what the payout ratio actually is, and then we could talk about why you think it's more important than things like yield. How do you think about the payout ratio?

Peters: Well, payout ratio defined is simply the dividend rate of a company divided by the earnings. So, thinking about it very simply, if a company pays out, say, $2.00 a share and has $5.00 a share of earnings, two divided by five is 0.4, or 40%. So, that's your payout ratio. The reason I find the payout ratio to be even more powerful than the dividend yield is that dividend yield is partially to mostly--depending on the situation--a valuation statistic. If the stock price is high or low, it's going to correlate to a low or high yield, all else being equal. The payout ratio is going a little bit further. There is a big, strong correlation between high payout ratios and high dividend yields; but the payout ratio is also going to give you a sense of perspective that the company is or is not devoting a significant share of its earnings to the dividend, and it provides you with a framework for evaluating whether or not that dividend is safe and likely continue to grow.

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