Nothing makes me happier than a fundamentally strong dividend growth stock (except for my daughter). Reviewing a company’s dividend payout ratio is critical to determining the strength of a company’s dividend. Over the years, we have figured out the percent range that we consider perfect for the metric. In this article, we will explain the dividend payout ratio, why it is such an important metric, discuss the perfect payout ratio, and create a list of companies that have a perfect payout ratio.
Dividend PAyout Ratio – Why is it so important?
The dividend payout ratio is one of the most critical investing metrics for dividend growth investors. In fact, the payout ratio is such a critical metric, it is the second metric of the infamous Dividend Diplomats’ Dividend Stock Screener. The dividend payout ratio calculates the percentage of a company’s earnings that are paid to shareholders as dividends. The dividend payout ratio is very simple. It is calculated as follows: Dividends Per Share / Earnings Per Share. To demonstrate, if a company pays an annual dividend of $4.00 per share and earns $10.00 per share during the year, their dividend payout ratio is 40%.
The metric helps an investor assess the safety of a company’s dividend. In the long run, a company cannot sustain a dividend payment that exceeds, or nearly exceeds, their earnings. That is a simple fact. The dividend payout ratio is a quick way to identify companies that are paying too high of a dividend. This is why the metric is so important to investors.
As dividend growth investors, we are not simply looking to build a dividend income stream. We are looking to build a GROWING dividend income stream. If the dividend payout ratio is too high, the company may not be able to grow their dividend. Further, the company may even have to cut their dividend if their earnings suddenly collapse. Normally, I would say the latter scenario is rare. However, during the Coronavirus pandemic, too many companies have cut their dividend due to their earnings per share suddenly falling off a cliff.
What is the Perfect Dividend Payout Ratio?
The dividend payout ratio means nothing if you do not know how to interpret the number, right? Don’t worry, that is why we are here! In this section, I will discuss what we consider the sweet spot for dividend payout ratio and why we consider this the range perfect.
When screening for stocks using our dividend stock screener, we look for stocks with a payout ratio less than 60%. We believe that companies with dividend payout ratios below 60% have achieved the right balance of returning capital to shareholders and reinvesting earnings into a company’s business. If the company’s ratio is below the mark, we will continue on to Metric 3 of our screener. If the company’s ratio is above the mark, we will further scrutinize the company’s ratio to assess the dividend safety and opportunity for future dividend growth.
There is a reason why I am further defining the perfect payout ratio. A company that passes our stock screener may have a dividend payout ratio anywhere between .1% – 60%. That is a very wide range! Further, we still like a strong return as shareholders. If a company’s payout ratio is too low, it could indicate a poor dividend yield. Personally, I don’t invest in company’s to receive a dividend yield of less than 2%. That is not enough dividend yield. In that case, I would rather invest in a dividend focused ETF or index fund, both of which pay higher dividend yields.
An example of a company with too low of a dividend payout ratio and dividend yield is Mastercard. At the time this article was published, their dividend yield and payout ratio were .53% and 17.7%, respectively. Mastercard easily passes Metric 2 of our stock screener. However, with a payout ratio below 20% and a .53% dividend yield, one could argue that their dividend is too low and they should pay out a larger percentage of their earnings.A Perfect Dividend Payout Ratio is between 40% - 60%.Click To Tweet
This is where the Perfect Dividend Payout Ratio enters the equation. The two of us often talk about the dividend sweet spot. We’ve mentioned it in countless articles and many of our Youtube videos. Nothing makes us happeier than findin a company with a ratio between 40% – 60%. A dividend that falls in that range is considered perfect.
Creating the List
Now that Lanny and I shared our secret, target payout ratio range, I wanted to take some action and find some dividend stocks that currently have a perfect payout ratio. We’re hungrier than ever to reach financial freedom. Let’s turn some of this hard work and knowledge into action! We are both big fans of creating investing lists. Lists help us identify target investment opportunities by criteria. Over the years, some of our favorite lists include our Top 5 Foundation Stocks, Bert’s 5 Stocks to Buy Now, Dividend Aristocrats with Low Debt, and our monthly dividend stock watch lists.
Naturally, my first instinct was to create a list of dividend stocks with the perfect dividend payout ratio. The rest of this section will outline the parameters used when creating the list. To identify the stocks, I used the listing of Dividend Champions, Contendors, and Challengers per DRIPInvesting.org. This website is a fantastic resource that offers a lot of great, free tools for investors. The infamous CCC spreadsheet started by the late David Fish continues to be produced. The spreadsheet contains all the metrics of our dividend stock screener (and much more) in an easy to filter and sort format.
Dividend Stocks with a Dividend Yield Greater than 2%
I didn’t just select a 2% dividend yield because it is a nice, round number. There are two primary reasons. First, I selected 2% because that is the approximate yield of the S&P 500. Therefore, when investing in individual stocks, I look for company’s with a dividend yield above the broader market. Otherwise, why wouldn’t I simply invest the capital in an index fund and earn a 2% annual dividend with a dividend growth rate of 7%-8%?
Second, using a 2% dividend yield allows me to eliminate companies similar to Mastercard. These are companies with a low dividend yield and a low dividend payout ratio.
Dividend Stocks with 20+ Consecutive Annual Dividend Increases
The easy route would be to only include Dividend Arisocrats on this listing. A Dividend Aristocrat is a company that has increased their dividend for 25+ consecutive years, has a minimum market cap of $3b, and is on the S&P 500. However, that would exclude a large population of dividend stocks that are not on the S&P 500 or have still demonstrated their ability to increase their dividend.
Therefore, for this list, I simply included companies that have increased their dividend for 20+ consecutive years. Why did I select 20 years? If a company has increased their dividend for at least 20 years, the company has increased their dividend through the dot-com bubble, the Global Financial Crisis, and the pandemic (potentially). In my mind, still increasing your dividend through these major events demonstrates the company’s ability to increase their dividend over the time. That is ultimately what we are trying to achieve with this list.
Dividend Payout Ratio between 40%-60%
Last, but definitely not least, the company must have a perfect payout ratio between 40% – 60%. This may seem obvious, given the title and nature of the article. However, it is a major requirement for this list. Therefore, I felt the need to include it!
Stocks with a Perfect dividend Payout Ratio
We have arrived at the fun part. The parameters have been outlined to identify companies with a perfect payout ratio. Now, let’s identify the full population of companies with payout ratios between 40% – 60%. Before reviewing the list in detail, I must say, the results were very surprising. I did not anticipate this many companies appearing on the list. It is a great reminder that there are plenty of great dividend growth stocks out there consider for investing. Without further ado, here is our listing of stocks with perfect dividend payout ratios.
This list includes not 1…not 2…not 3….companies. Rather, this list includes 33 dividend paying stocks. Like I mentioned eralier, that is a lot more companies that I was expecting. There were several trends that jumped out at me from this listing.
First, did you notice that there are a lot of bank stocks on this listing? The banks range from a Dividend Aristocrat (People’s United Bank) to many small community bank stocks. That is due to the fact that we did not include a minimum market cap on this listing. As a result, there are a lot of great dividend paying community bank stocks on this list. The best part is that we both own one of the community banks: Norwood Finnancial Corp. (NWFL).
Second, there are some very strong Dividend Aristocrats on this listing. The companies I am thinking about include Archer Daniels Midland, T.Rowe Price, Emerson Electric, Illinois Tool Works, Target, and Walgreens. I own all buy one of the companies from the proceeding sentence as well (Walgreens). However, I may now have to take a look at the drug store to compliment my position in CVS Pharmacy. Interestingly, both Emerson Electric and Target are also on my 5 Stocks to buy now, always, and forever listing.
Lastly, I am very impressed with the strong dividend yields of companies on this listing. A lot of the companies have dividend yields north of 3.5% on this listing. This fascinates me because it proves the point that companies pay can pay a strong dividend while reinvesting a portion of their earnings into the company.
Hopefully you have found this article helpful and learned something new today. Overall, our goal on this website is to help educate and teach as many people as possible about the wonderful world of dividend growth investing. Dividend investing does not have to be difficult. That is why we keep our dividend stock screener simple, with only 3 metrics. It is imperative that you understand how to use the dividend payout ratio to assess the safety of a dividend and find companies that pay a strong, safe, and growing dividend.
This listing shows the companies that pay a nice yield and a “perfect” amount of their earning inthe form of a dividend. We will always preach that a 40% – 60% dividend payout ratio is the perfect balance. Currently, 33 companies check this box. Hopefully, soon, we will add more due to strong dividend increases after the pandemic. Please let me know what you consider a perfect dividend payout ratio in the comments section of the article. I am looking forward to reading your thoughts about the article and listing of the companies included within.
How many stocks from the list do you own? What do you consider a perfect dividend payout ratio? Do you own individual stocks with a less than 2% dividend yield?