We don’t support this browser anymore.
This means our website may not look and work as you would expect. Read more about browsers and how to update them here.

Skip to main content
  • Register
  • Help
  • Contact us

Investing for income – 3 ways to check if a dividend’s sustainable

Emilie Stevens looks at what makes a sustainable dividend when researching stocks.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

Last week we highlighted the power of dividends for growing your wealth.

The challenge is finding companies offering a healthy dividend yield which can afford to keep paying it.

Here are a few things we look for when hunting dividend payers.

This article is not personal advice. If you're not sure whether an investment is right for you, please seek advice. All investments and income can fall as well as rise in value so you could make a loss. Yields are variable and not a reliable indicator of future returns.

Can the company afford its dividends?

When looking at whether a company can afford to pay its dividend, we make two checks – one looks at a company’s profits and the other at its cash.

We’re looking at how much of a company’s profits, or cash, it’s paying out as a dividend. You’ll often hear it referred to as ‘dividend cover’. A dividend that’s well covered means the company has enough cash or profits to pay the dividend - although that doesn’t mean the dividend’s guaranteed.

Dividend cover – a check on profits

Profit is often where investors start when looking at whether a company can afford to pay its dividend. It’s a readily available number and that makes it a quick sense check.

We do this by calculating dividend cover which divides profit per share by the dividend per share.

Dividend Cover = Earnings per share / Dividend per share

A ‘good’ level of cover will vary between sectors, but generally bigger is better.

A dividend cover of 1 shows that this year’s profits just covered the dividend. Put another way, the company paid out all this year’s profit as a dividend. That doesn’t leave much of a buffer if profits go south.

A dividend cover of less than 1 means this year’s profits weren’t enough to cover the dividend. That isn’t sustainable for long. It could mean a dividend cut is on the cards, not good news for those investing for the dividend.

Checking if profits are enough to pay the dividend is a good sense check. But it’s not really enough on its own.

Free cash cover – cash is king

Cash keeps businesses running – it pays electricity bills and employees. And it’s cash that’s paid out in a dividend.

As shareholders we’re interested in the pounds and pence a business generates from its day-to-day operations after it has funded new investments, whether that be for international expansion or for maintenance. This is known as ‘free cash’. It’s the cash actually available to pay our dividend.

Free cash = Cash from operating activities - Capital investment

Like dividend cover, we’re interested in whether the amount of free cash covers the total dividend to be paid that year.

Free cash cover = Free cash / Total Dividend

A result above 1 indicates the business generated enough cash to pay the dividend this year. Like before, the higher the number the better, but we must always compare a result to its competitors and it should be remembered ratios should not be looked at in isolation.

Track record

Last time we looked at the power of compounding and how reinvesting dividends can make a dramatic difference to the size of your investment over time, although of course there are no guarantees.

You may decide to look at companies that have shown the ability to pay a dividend over several years and what happened during those years.

Profits can take a hit when the economy goes through a bad patch, and you should be interested in what happened to the dividend during those years. If a company can hold or grow its dividend when others are struggling that could be a sign that it’s a defensive rather than cyclical business – and more able to weather economic downturns and in theory maintain the dividend.

In reality past performance is not a guide to the future and dividends may at some stage be inevitably cut regardless of how well it’s done in recent years.

Next up – putting theory into practice

No test should ever be used on its own, it’s best to use it in combination with others so we can build a clearer picture.

In the next article we’ll be putting these tests into practice on the UK stock market. Sign up to our weekly Share Insight below and we’ll send you a copy.

Share insight: our weekly email

Sign up to receive weekly shares content from HL

Please correct the following errors before you continue:

    Existing client? Please log in to your account to automatically fill in the details below.

    This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.


    Your postcode ends:

    Not your postcode? Enter your full address.


    Hargreaves Lansdown PLC group companies will usually send you further information by post and/or email about our products and services. If you would prefer not to receive this, please do let us know. We will not sell or trade your personal data.

    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

    Editor's choice – our weekly email

    Sign up to receive the week's top investment stories from Hargreaves Lansdown. Including:

    • Latest comment on economies and markets
    • Expert investment research
    • Financial planning tips
    Sign up

    Related articles

    Category: Markets

    Next week on the stock market

    What to expect from a selection of FTSE 100, FTSE 250 and selected other companies reporting next week.

    Aarin Chiekrie

    08 Dec 2023 4 min read

    Category: Shares

    Are there investment opportunities in aerospace and defence?

    It’s an exciting time for the aerospace and defence industry. Here’s why and a closer look at some of the biggest UK-listed players.

    Aarin Chiekrie

    07 Dec 2023 4 min read

    Category: Shares

    3 retail share ideas to watch this Christmas

    Christmas is fast approaching and with it comes spending. We look at three companies that could benefit from the Christmas shopping frenzy.

    Aarin Chiekrie and Sophie Lund-Yates

    06 Dec 2023 4 min read

    Category: Shares

    Is now the time to consider Japanese shares?

    A closer look at why investing in the Japanese stock market has become appealing to investors.

    Kathleen Brooks

    04 Dec 2023 7 min read