When looking at dividend paying stocks, you should ask yourself how realistic is it for this company to continue paying its dividend. A big factor in dividend growth is to keep dividends to a manageable percentage of net income, which is known as the payout ratio. A low payout ratio means that it is easy for a company to pay their dividends without exhausting their profits. So, when investing, you not only want to invest in a company that has a high dividend, but you want to see a low payout ratio as well, since that means they are more likely to continue to be able to pay the nice dividend.
A Concern with Payout Ratio
Here is a case study about why a payout raio matters. A company that currently pays a 5.2% dividend is Integrys Energy. However, its payout ratio is currently 104%, which is completely unsustainable. To highlight this, the company paid out all but $7 million of its net income in dividends last year. To keep this up would be financial suicide. However, it the company were to cut its dividend, its stock price would take a huge hit as well.
Update for 2012: Fast forward to today, and the company is trading at the exact same level it was two years ago when I wrote this article originally. However, it has been able to keep its dividend at the same level, which means that it is earning enough income to make the payments.
When investing in dividend paying stocks, make sure you are keeping an eye on the payout ratio.