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A Jazz Air plane while still owned by Air Canada

Kudos to Corporate Canada for keeping those dividends coming through the financial troubles of the past year.

With that formality out of the way, let's try to get a sense of what's ahead for dividend investors by studying an indicator called the dividend payout ratio. Technically, this ratio measures how much of a company's earnings are being paid out to shareholders each quarter. But you can think of it simply as a sign of how comfortably a company is managing its current dividend and, by extension, whether there's a risk of a cut or room for an increase.

A list of payout ratios for all dividend-paying stocks and income trusts in the S&P/TSX composite index was supplied for this column by CPMS, an equity research and portfolio analysis firm owned by Morningstar Canada. CPMS used annualized dividends based on the most recent quarterly payout, and expected earnings for the current fiscal year. You can read the full list of payout ratios below.

Investors typically size up a dividend stock by looking at its yield. Payout ratios work in somewhat the same way - very high numbers are alarming, while low or middling numbers tell you a lot about a company's philosophy on paying dividends versus keeping money back to fund future growth.

"The dividend payout ratio is definitely something that investors need to watch, especially in this day and age," said Duncan Anderson, a portfolio manager with MFC Global Investment Management.

He explained that before the recession, corporate earnings were on the rise and companies could increase the dividends paid to shareholders while keeping their payout ratios the same. Lately, though, earnings have weakened and in many cases sent payout ratios higher.

There's nothing unusual in this. Corporate boards decide what portion of earnings they want to retain to build the business and how much will be paid out as dividends. If they've calibrated things right, they'll be able to maintain this balance through both good times and bad.

"Payout ratios would go down a little bit in an economic upturn and would probably be allowed to rise a little bit in a downturn, unless management sees something that concerns them and they feel there's a need to preserve additional capital," said Doug Raymond, co-manager of the $9.1-billion RBC Canadian Dividend Fund.

Mr. Raymond is referring to a dividend cut here, which is something that has happened far less with Canadian companies in the recession than with U.S. firms.

"In Canada, we're quite lucky in that most companies have dividend policies that are consistent with the cyclicality of their businesses," said Stuart Kedwell, Mr. Raymond's partner on RBC Canadian Dividend.

Still, dividend cuts do happen. Manulife Financial Corp., Magna International Inc., Biovail Corp. and Russel Metals are among the companies that have trimmed their quarterly payout in recent months. Income trusts that have cut their distributions include Yellow Pages Income Fund, Jazz Air Income Fund and, just this week, Consumers' Waterheater Income Fund.

Dividend yields - the percentage return you get from a company's annualized dividend based on its share price - are one way of assessing the solidity of a dividend-paying stock. Before it halved its monthly distribution, Consumers' Waterheater units had a five-alarm yield of 27 per cent. Compare that to the 8.2-per-cent yield of the S&P/TSX income trust index, which is a benchmark for trusts.

Think of dividend yields as an indicator of risk that you investigate further by consulting the dividend payout ratio. For example, check out Manitoba Telecom Services, which has a dividend yield in the high 7-per-cent range. The payout ratio of 95.2 per cent helps explain why investors have pushed this stock lower, thereby driving up the yield. Note how high MTS's payout ratio is in comparison to BCE and Telus, which are similar companies in the telecom sector.

Payout ratios are also worth consulting for signs of a company's ability to increase its dividend. For discerning investors, the fact that a company pays a dividend is not sufficient. They demand a rising dividend, which means an ever-increasing flow of quarterly cash and, quite often, a share price that rises as well.

MFC's Mr. Anderson said the big banks are an example of how dividend growth can be constrained by high payout ratios.

"We've hit a period where we're not going to see a lot of dividend increases from the banks until earnings can grow further and we can get those payout ratios down again," he said.

Bank of Montreal and, to a lesser extent, CIBC jump out for having the highest payout ratios by a wide margin among the major banks. This helps explain why there was so much worry last fall and winter about BMO having to cut its dividend.

When the bank's shares hit their 52-week low of $24.05 in February, the dividend yield reached a scary 11.6 per cent. At the same time, BMO's payout ratio was moving up to the 70-per-cent range.

This compares to about 45 per cent before the recession for the big banks on average and about 35 per cent a decade ago, said Murray Leith, director of research at the Vancouver-based investment dealer Odlum Brown.

Should investors be worried about the banks with higher-than-normal payout ratios?

"I don't think any of the banks are going to cut their dividends now," Mr. Leith said. "Their core businesses are operating well, and the economic wind seems to be blowing in the right direction."

When interpreting dividend payout ratios, it's important to note the different trends in sectors and types of companies. Utilities and telecommunications companies tend to have higher ratios because they're mature businesses with fewer opportunities to reinvest their earnings. In these cases, investors generally get a higher-than-average dividend yield, but less opportunity for dividend growth.

Smaller, faster-growing companies tend to have lower payout ratios, which suggests lower yields but more dividend growth potential.

"If a company has a relatively low payout ratio, it means they're retaining more earnings, and those earnings will be put back into the business to help it grow," said Mike Lough, co-manager of the $3-billion TD Dividend Growth Fund. "You have to have growth in the earnings to have growth in the dividend."

It's hard to generalize about ideal payout ratios, but Mr. Leith was good enough to take a crack at it. "Payout ratios from 35 to 50 per cent are probably the sweet spot," he said. Ratios of 70 to 80 per cent make him cautious. "I'd prefer not to go beyond that."

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