Payout Ratio: Important Dividend Metric, Too Often Overlooked

Payout Ratio: Important Dividend Metric, Too Often Overlooked
1 comment | September 12, 2011 | includes: DUK, ETE, FTR, MO, NOK, T, VGR

I was recently talking to one of my friends last week. He had about $600,000 invested in high yield stocks. These were companies paying well above what they were earning. I told him to be careful as these companies could cut their dividends in the future. This seems like a common problem for investors who overlook one simple metric, which is the payout ratio. The payout ratio is simply the percentage of earnings that are being paid out in dividends. Here are four companies that are actually paying out more than they take in.

Frontier Communications Corporation (FTR), a communications company, provides regulated and unregulated voice, data, and video services to residential, business, and wholesale customers in the United States. It offers local and long distance voice services, including basic telephone wireline services to residential and business customers.

Frontier pays nearly 11% in dividends. It sounds nice, except for the fact the payout ratio is around 450%. The company pays 75 cents a year and isn't even expected to earn half that next year. Another issue with Frontier is that it is in a dying area of business. It primarily deals with landlines. Landlines are quickly going away as people start switching to wireless telecom carriers.

Nokia Corporation (NOK) manufactures and sells mobile devices, and provides Internet and digital mapping and navigation services worldwide. Its devices & services segment develops and manages a portfolio of mobile devices, such as mobile phones, smartphones, and mobile computers; services; applications; and content.

Nokia pays a 7.6% dividend. The payout ratio is about 110%. This is set to increase as the company's earnings are set to decrease. Apple (AAPL) and Google (GOOG) have been taking a bite out of Nokia's market share. Nokia is already said to be stumbling as it tries to find new ways to innovate.

Energy Transfer Equity, L.P., (ETE) through its direct and indirect investments in the limited partner and general partner interests in Energy Transfer Partners, L.P., engages in midstream, intrastate, and interstate transportation of natural gas, as well as in storage of natural gas in the United States.

Energy Transfer Equity pays a 6.5%. The payout ratio is more than 200%. ETE has a good business model and I do like the MLP space, but the fact that it pays out so much is a huge red flag.

Vector Group Ltd., (VGR) through its subsidiaries, engages in the manufacture and sale of cigarettes in the United States.

The company pays an 8.5% dividend. The payout ratio is over 200%. Vector's brand of cigarettes have a very small market share. With the company paying out all its earnings and taking on debt, it is not putting any capital into potential growth opportunities.

The payout ratio can tell us what future distributions will look like. A few things to note is that you also need to look at future earnings growth. If a company cannot match distributions with earnings, it may be time to sell. Here are three companies that have a nice yield and low payout ratios.

AT&T Inc., (T) together with its subsidiaries, provides telecommunication services to consumers, businesses, and other service providers worldwide. Its Wireless segment offers wireless voice communication services, including local wireless communications service, long-distance service, and roaming services.

AT&T pays a 6.2% dividend. The payout ratio is 50%. The company has a strong base of customers. There is plenty of growth in the dividend as well. The company is a strong blue chip as well as being a Dow component. AT&T is a favorite amongst many dividend investors.

Altria Group, Inc., (MO) through its subsidiaries, engages in the manufacture and sale of cigarettes, smokeless products, and wine in the United States and internationally.

Altria pays a 6.1% dividend. Its payout ratio is 93%. However, its earnings are suppose to increase substantially over the coming years, meaning the payout ratio will decrease. The company has some of the strongest brands around. Although, the dividend may not be as high as Vector's, the company is much safer.

Duke Energy Corporation (DUK) operates as an energy company in the Americas. It operates through three segments: U.S. franchised electric and gas, commercial power, and international energy.

Duke currently pays a 5.3% dividend. The payout ratio is 64%. Duke is one of the largest utility companies in the U.S. Americans will always need energy and consumption is set to increase. Duke is an extremely stable company and with its recent purchase of Progress Energy (PGN), the company is set to increase its earnings power.

These three companies are great example of strong dividend payers with a low payout ratio. Always be careful when investing. Sometimes companies have high yields for a reason simply because there exists more risk. The best advice I can give in this case is "Slow and steady wins the race."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.