In last Wednesday's post I isolated what I think are the two most important questions to ask about a firm to decipher the changes of a dividend cut. I'll expand on why I believe these questions are crucial in today's post.
1. How Does This Company Make Money? This is important. Does the company offer a product or service that is unlikely to be sacrificed during recessionary conditions. In other words, how stable are it's cash flows?
Examples:
Campbell Soup (CPB) - Manufacturer of soup and other basic foods
Clorox (CLX) - Manufacturer of cleaning products, kitchen bags, etc.
2. What Is The Payout Ratio of Dividends on Earnings? What is the ratio of dividends paid per share divided by earnings per share. If you feel good about the answer to question number 1, a pay out ratio of less than 50% is ideal and increases the likelihood that this firm will not cut it's dividend.
Examples:
Procter & Gamble (PG) = 37%
Wal-Mart (WMT) = 28%
This is not a be all and end all, however asking these two questions is a good start towards selecting a dividend investment that is unlikely to chop their dividend in the future.
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