A common measure of dividend sustainability is the payout ratio, the percent of earnings that are paid out to shareholders. Unfortunately, earnings don't always represent how much money is available to management because they include noncash items. That's why free cash flow -- what's left of sales after the expense of running the business and buying and maintaining physical assets -- can provide a more useful way to gauge how much a company could pay out and how likely a dividend cut might be.
For high-yielders under threat, like Realty Income (NYSE:O), ExxonMobil (NYSE:XOM), and Gilead Sciences (NASDAQ:GILD), comparing free cash flow to the dividends helps us determine how easily the company can keep doling out the cash while working through obstacles. Great dividends need to be sustainable, and that requires free cash flow.
Source: Motley Fool
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