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The Secret To Becoming A Great Dividend-Earner

May 8, 2012 by  

The Secret To Becoming A Great Dividend-Earner
PHOTOS.COM
The payout ratio is the percentage of a company's earnings used to pay its dividend.

When I sit down to select dividend-paying stocks for my readers, my personal portfolio, and my mother’s portfolio, I don’t just consider the “usual” numbers.

Of course, I look at important things like brand quality, profit margins and sales growth.

But I also use a little-known, very powerful concept called the “payout ratio” to guide my decisions.

The payout ratio is the percentage of a company’s earnings used to pay its dividend. My rough rule of thumb is to stick with companies with a payout ratio of less than 60 percent.

You see, a company with a high payout ratio—one that pays out around 75 percent of its earnings as dividends—may struggle to maintain its dividend if it hits a rough patch or if the economy weakens.

Utility companies tend to have higher payout ratios. Often, it’s because they are mature companies with less room for growth. But even in this industry I stay away from super-high payout ratios. They don’t provide a “cushion” for tough times.

However, 60 percent is a great middle-of-the-road number for investors interested in a safe payout AND some future growth.

You see, if a company has a payout ratio of less than 60 percent, it’s plowing 40 percent or more of the earnings back into the business, investing in its own growth. (A 2008 study showed 60 percent of the companies with a payout ratio of 60 percent or less raised their dividends down the road.)

To compute a company’s payout ratio, I divide the annual dividends per share by the annual earnings per share. I find both numbers in the company’s annual report. (For an even faster check, Yahoo Finance lists the payout ratio on its “key statistics” page.)

Here are a few of my favorite dividend-payers and their payout ratios:

Company Payout Ratio
McDonald’s 48%
Microsoft 26%
3M 37%
ExxonMobil 22%
As you can see, each company has a payout ratio well below 60 percent. They have plenty of money to both pay dividends and invest in their businesses. And earnings could theoretically fall in half before they’d have to think about cutting their dividends.
Even better, these are all companies that will grow earnings in good times and bad. And with their super-safe payout ratios, they’ll pass on that growth to you no matter what.
Here’s to our health, wealth and a great retirement,

-Dr. David Eifrig,

Editor, Retirement Millionaire

P.S. In addition to these kinds of common sense investment tips, I’ve compiled a handful of safe investments you can make right now… all of which pay a high yield. Many retirees are using these investments to get all the income they need for the rest of their lives. I think you’ll be surprised at what these investments are… and how simple they are to use. You can learn about them right here.

Dr. David Eifrig Jr.

is the editor of two of Stansberry's best advisory services. One of his advisories, Retirement Millionaire, is a monthly letter showing readers how to live a millionaire lifestyle on less than you'd imagine possible. He travels around the U.S. looking for bargains, deals and great investment ideas. Already his average reader has saved $2,793 since 2008 (documented in each Retirement Millionaire issue). He also writes Retirement Trader, a bi-monthly advisory that explains simple techniques to make large, but very safe, gains in the stock and bond markets. This is a pure finance play and the reason Porter Stansberry loves having "Doc" on the team. Doc holds an MBA from Kellogg and has worked in arbitrage and trading groups with major Wall Street investment banks (Goldman Sachs). In 1995, he retired from the "Street," went to UNC-Chapel Hill for medical school and became an ophthalmologist. Now, in his latest "retirement," he joined Stansberry & Associates full-time to share with readers his experiences and ideas.

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