When looking for a quality dividend stock, one thing I like to look at is the Dividend Payout Ratio. What I like to see is a stock with a high dividend yield and a low payout ratio. Now you maybe wondering what constitutes a high yield and a low payout ratio, and this isn’t an easy thing to answer because it largely depends on the stock and its industry.

What I like to do is check out the historic dividend yield and payout ratios for a given stock. If the current Yield is higher then the historic yields then this means that we are looking at a high yield for this stock. Once this is established it is always a good idea to check out the companies competitors to see what kind of yield they are giving out. Once again, if our stocks yield is higher then theirs, then we have a high yield on our hands. You don’t always want to select the highest yield in an industry, because a high yield sometimes points to a company that is in trouble. This is where the payout ratio comes into play.

The payout ratio, is the percentage of the companies earnings that they pay out to their shareholders and is calculated by using the following formula DPR = Dividends Per Share / EPS. Where DPR stands for the Dividend Payout Ratio, and EPS stands for Earnings Per Share. By Itself the Dividend Payout Ratio is not very helpful because growing companies will generally have a lower payout ratio because they are using their money to grow the business, while companies in mature industries will have higher payout ratios because paying out dividends is the best use for their extra money, since they don’t need to grow the business at the same rate that newer companies do. This is why we look at the historical payout ratio, and see if the current ratio is less then the historical value. If it is, then this means that the company should be able to retain or grow the dividend in the near future. If the ratio is higher then the historic values then this could be a flag that the company is in trouble.

Another good practice to do with the Dividend Payout Ratio is to look into the company’s rivals payout ratios. If the company’s payout ratio is less then the industries average then there is a good chance we are looking at a mature company that will be able to sustain their dividend and hopefully increase it. If the Dividend Payout Ratio is higher then the industries average then we might have a company that is in trouble or one that should be dedicating more money towards growing the business instead of paying out dividends.

Next time you are looking into a dividend based stock, take a moment to check out the Dividend Yield and how it relates to the Dividend Payout Ratio. You just might find that the stock you thought was good might not be that great, or you might come across a little more proof that your stock is a winner.

Disclaimer: Any information contained in the above article represents my opinions only, and should not be construed as personalized investment advice. I cannot assess, verify or guarantee the suitability of any particular investment to any particular situation and the reader of the article bears complete responsibility for its own investment research and should seek the advice of a qualified investment professional that provides individualized advice prior to making any investment decisions. All opinions expressed and information and data provided therein are subject to change without notice.