Secondly, Tam said, the company’s most recent financial statements might also provide hints on the capacity to pay dividends. Here, he added, investors might look to the dividend payout ratio. This measures the proportion of a company’s earnings cash flow that is being paid out as dividends. If this ratio exceeds 100%, it means that the company is paying out more than it is making, which it can’t keep doing forever unless it continues to issue debt which generally has negative implications for an existing investor. Tam noted: “Though there is no hard/fast rule, generally investors should look for lower (more conservative) payout ratios. In certain sectors (like energy and utilities), operating cash flow might make more sense in the calculation. For these sectors look for an even more conservative (lower) payout ratio on cashflows.”
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Using information from Morningstar CPMS, Tam screened for Canadian-listed companies with higher-than-usual payout ratios. Results cited include Transalta Renewables, Dream Impact Trust, Chartwell Retirement, Extendicare Inc. and Acadian Timber,
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Tam noted his screen used both trailing and estimated cashflows and earnings. In the case of estimated figures, shown is a projection of the payout ratios, should street analyst estimates come true. In the case of REITs, Tam used funds from operations as a measure for cash flow. He said: “Investors should be mindful that there’s no guarantee that these companies will cut dividends in the future, only that they might look a bit stretched to continue to do so in the current manner.”
“It’s also worthwhile noting,” he added, “that a stock that cuts dividends isn’t necessarily bad for all investors. It might be the case that the company is keeping its earnings and cashflows in-house to finance projects that generate revenue in the future. For a dividend investor, not great. However, a growth investor with a longer investment time horizon might find the company quite attractive.”