Payout Ratio, Free Cash Flow, and Dividend Safety

Dividend safety is a measure of how sustainable a company's dividends are. If a corporation has a very high payout ratio, it would usually have a low dividend safety since it is unlikely that it’ll be able to continue paying them. Dividend safety measures can be found on platforms like Simply Safe Dividends, and fall on a scale from 0 to 100

Companies with stable, predictable earnings like utilities and consumer staples tend to have a high dividend safety since their profit doesn’t feature large fluctuations.

Highly cyclical companies - ones whose performance typically match the economy - tend to cut dividends during recessions, giving them a low dividend safety. Cyclical sectors include automobiles, travel, non essential retail, and banking. This is because in downturns, non essentials like vacation are cut first and people often default on loans.

For example, the dividend safety of Procter & Gamble is 99 because they have increased dividends for 68 years (Dividend King) and have a strong balance sheet. Prior to its crash in 2022, AT&T had a dividend safety of 40 due to having a payout ratio larger than 100% and heavy debt.

At the end of the day, dividend safety is a question of risk-tolerance. This right dividend safety is different for everyone, but one thing holds true for all investors: it's important to understand what you're buying.

Credit: Simply Safe Dividends