Payout Ratio

It’s all about safety. Before you dive in and pick great stocks that will generate huge amounts of money, you want to ensure that the stocks will stay great and help you meet your financial goals. If the company’s finances are not in good shape, it’s likely to disappoint you sometime down the road. So be sure the company can continue with its dividend policy.

Warren Buffett’s first rule of investing is “Don’t lose money.” His second rule is “Don’t forget rule #1.”

Dividend investors should heed Buffett’s words. In order for the compounding machine to gain momentum every year, the dividend needs to grow. If the company can’t maintain dividend growth and has to slash the dividend, that derails the train (and probably the stock price). You’ll most likely have to sell your stock at a lower price and start over with a new one.

By looking at a company’s payout ratio, you can avoid most of the problem stocks that could lead a portfolio off the rails.