A suitable debt-to-EBITDA ratio will vary from one industry to the next, but in my experience, most companies will continue to pay dividends until their net debt is three to four times EBITDA or higher. Most companies want to maintain “investment-grade” credit ratings from agencies like Moody’s and S&P Global and will manage their debt levels accordingly.
3. Is there room for the payout to grow?
Lastly, the dividend payout ratio will measure how easily a business can afford its dividend payouts by comparing dividends paid to earnings generated in a given period. Companies will often set their dividend strategy with a sustainable payout ratio in mind.
If a company carries too high a payout ratio, the dividend is in greater danger of being cut if the business experiences an unexpected setback to its operations. Like the debt-to-EBITDA ratio, a healthy payout ratio is sector dependent, but keeping it below 70% to 80% can serve as a decent benchmark across industries. On the flip side, a low payout ratio also means the company has room to increase its payout over time.
Some investors like high-yielding stocks, while others are attracted to reliable dividend payers with a track record measured in decades. Regardless of your preference, you want to identify companies that can sustain their payouts. Using these tips, you have the high-level tools to evaluate any business and its potential as an income generator in your portfolio.